Economists warn that Tuesday’s big spending federal budget means hikes to interest rates are likely to occur sooner rather than later.

The federal government certainly put its money where its mouth is in Tuesday’s budget. “After outlining its social agenda in the September 30, 2002 Speech from the Throne, the government followed through with the dollars and cents,” says TD Bank, noting that it outlined $17.4 billion in new spending measures, which will push total program spending up 20% between fiscal years 2002-03 and 2004-05 — the fastest three-year rate in two decades.

“The predominance of spending measures is a negative for bonds,” notes BMO Nesbitt Burns. “Net new fiscal stimulus in this budget totals nearly one percentage point of GDP over the next two years. This will put more pressure on the Bank of Canada to counter with offsetting monetary tightening, especially since the Bank believes there is already too much stimulus in the system. As well, Ottawa is expecting to borrow a net new $5.8 billion in the coming fiscal year, after a net paydown of $3.4 billion this year.”

The cut in capital taxes is a modest plus for stocks, BMO says. And, the shift in corporate tax treatment for resource companies is another small improvement, it says. “However, aside from these moves, there is precious little in the way of new measures in [the] budget for equities.”

BMO also notes that the mix of a loosening fiscal policy and a tighter monetary policy is a classic recipe for a strengthening currency.

“While there were some modest tax cuts included in Tuesday’s budget, there is no mistaking the spending thrust to this year’s fiscal plan. One issue with Ottawa’s spending spree is that it works at cross-purposes with the direction the Bank of Canada is now taking on monetary policy. Ramped up government spending will indirectly prompt the Bank to hike short-term interest rates more than would otherwise have been the case in the year ahead,” BMO concludes.

RBC Financial Group says that the additional stimulus will likely raise the talk in markets of a more aggressive Bank of Canada in the period ahead as they attempt to stave off inflationary pressures. “Given that we are already on the high side of consensus forecasts for both growth and interest rates, we are not inclined to revise our outlook higher,” it says.

CIBC World Markets is more cautious, saying, “The Budget does not alter odds that the Bank’s forecast growth acceleration, and the resulting need for interest rate hikes, will in fact materialize.”

TD says that Tuesday’s budget is unlikely to have much of an impact on the timing of rate hikes, since the government had probably already built much of the new stimulus (about 0.5% of GDP per year over the next two years) into its forecast. “In any event, the actual amount of stimulus may be much less. Notably, with a large share of the new transfers for health set aside in trust funds, it is uncertain when they will be spent or whether they will indeed go towards other purposes, such as deficit/debt reduction. Still, if anything, Tuesday’s budget is consistent with our view that the Bank of Canada will begin to raise interest rates as early as the March 4th policy announcement date.”