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(Bloomberg) — The Bank of Canada will have to keep rates higher for longer unless governments do more to dial back their spending, one of the country’s largest commercial lenders warned.

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Economists at Canadian Imperial Bank of Commerce say policymakers led by Governor Tiff Macklem have been left to do the “dirty work” of stalling the economy in order to bring inflation back to the 2% target. And while they acknowledge that lower federal fiscal spending has started to drag on growth as generous Covid-19 programs expire, they argue that cutting back further on state largesse would help to cool demand.

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“If the job of engineering that slowdown is left only to the Bank of Canada, monetary policy will have to squeeze on growth for a longer period than we previously thought,” CIBC economists Avery Shenfeld and Andrew Grantham said Monday in a report. “It’s not too late to consider a fiscal policy shift.” 

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CIBC’s comments come a week after Macklem was forced to restart his hiking campaign in an attempt to blunt the country’s surprising economic momentum. The unexpected move — which saw benchmark borrowing costs rise to 4.75%, the highest since 2001 — has raised questions about whether the central bank’s task of cooling price pressures is being complicated by government transfers as some Canadians brush off higher rates and keep consuming.

The report notes that provinces ratcheted up spending, including transfers to households meant to help with inflation, last year on the back of widespread revenue windfalls, adding stimulus even with the central bank in the midst of one its most aggressive rate-hiking cycles ever. 

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Shenfeld and Grantham also said that although the steep drop in federal expenditures is a drag on growth, the impact is probably muted as households continue to spend the transfers they received from Prime Minister Justin Trudeau’s government during the Covid-19 crisis. The CIBC economists conclude that additional fiscal tightening may mean interest rates start to fall earlier, relieving some pain for households bearing the brunt of Macklem’s higher borrowing costs.

“Fiscal policy will represent a much more modest drag on growth this year, and will therefore not be materially assisting the Bank of Canada in cooling the economy’s inflationary fires,” they wrote. “The drag from fiscal restraint would be offset by the ability to chart a softer course on interest rates, by canceling further hikes we might still face and bringing forward the timing for some interest rate reductions.”

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Economists are increasingly of the belief that Trudeau’s government is working at cross purposes to the central bank. Nearly 70% of respondents to a Bloomberg survey say generous federal spending programs and higher immigration targets have led interest rates steeper than they would have otherwise needed to go.

The Bank of Canada’s mandate agreement, which was renewed by Finance Minister Chrystia Freeland at the end of 2021, includes a reference to the “joint responsibility” of the central bank and the government in achieving the 2% inflation target and promoting maximum sustainable employment. 

Her office defends the government’s spending levels as “responsible,” regularly notes that Canada has the lowest debt-to-output ratio among the Group of Seven and argues immigration is an important driver of economic growth.

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