Yields ticked slightly higher as the budget office forecast a deficit spike for 2025-26
The Parliamentary Budget Office (PBO) projected a big jump in Canada's federal deficit and downgraded the economy's growth forecast on Thursday, potentially putting upward pressure on bond yields and fixed mortgage rates.
In a new report, the PBO said it expected the deficit to climb to $68.5 billion in 2025-26, up from $51.7 billion in 2024-25, thanks to government spending plans and milder anticipated economic growth than originally expected.
Five-year Government of Canada bond yields, a key driver of fixed mortgage rates, ticked marginally upwards on Thursday morning. In the longer term, mortgage market watchers fear higher government spending could put upward pressure on those yields.
Deficit surge could weigh on rates
The PBO’s update, released ahead of the federal government’s fall budget, pointed to $115.1 billion in new spending over five years and a weaker economy as main culprits behind the deteriorating fiscal outlook.
"Compared to our March outlook, the federal debt-to-GDP ratio is 4.5 percentage points higher in 2029-30 and is no longer projected to be on a declining path over the medium term," the report said.
The report did not mention the government’s plans to ramp up defence spending to meet NATO targets, nor did it factor in Ottawa’s announced plans to reduce public service spending over the next three years.
The PBO flagged that Canada’s ongoing trade tensions with the United States have been weighing on tax revenues and pushing deficits higher as the Liberals also ramp up capital spending.
Mortgage market faces new headwinds
A larger deficit and weaker fiscal position likely mean higher government borrowing costs, potentially translating into higher bond yields down the line.
Five-year Government of Canada bond yields are a key driver of fixed mortgage rates. If yields continue to rise, borrowers could see less relief on rates in the coming months.
Fixed mortgage rates tend to move in lockstep with government bond yields, which are sensitive to fiscal policy and inflation expectations. But other factors are also likely to come into play in the months ahead including possible greater appetite for Canadian bonds, a safer asset than stocks, amid a souring economic outlook. That would probably send yields lower.
Recent weeks have seen bond yields on a steady descent, bringing fixed rates down. Meanwhile, variable rates fell last week after the Bank of Canada cut its benchmark rate for the first time since spring.
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