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Canada’s deficit below original target, but risks looms

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Canada posted a smaller-than-expected budget deficit for 2011-12 on Friday, giving Finance Minister Jim Flaherty some leeway to react if needed to what he called an "unstable" situation in Europe.

In addition to the jitters over the possible Greek exit from the euro, Flaherty faces a heated housing market at home and warned that new data on Friday showed no sign of moderation in Toronto, where a condo craze has spurred talk of a bubble.

The preliminary budget deficit came in at $23.5 billion for the fiscal year ending March 31, below the government's forecast of a $24.9 billion shortfall, or about 1.5 percent of gross domestic product.

The deficit-to-GDP ratio is one of the lowest among major Western economies and is part of the reason Canada is among the shrinking number of countries to retain a top-notch triple-A debt rating.

The lower deficit came despite big spending in the final month to compensate the province of Quebec for a sales tax change and pay for buy outs for thousands of public service workers that will soon be laid off as part of Ottawa's cost-cutting plan.

After year-end adjustments are made, the final figure could be closer to the government's estimate. Flaherty said the report showed Ottawa on track to balance the budget by 2015-16 as planned.

Canada's strong record on public finances means the monthly budget updates barely register with market players. But as tensions rise over the European sovereign debt crisis, analysts said investors take some comfort in the country's fiscal advantage.

"The government, echoing some of the recent things Mr. Flaherty has said, is obviously still concerned about conditions in Europe and I think that stands as the first line of defense if things do get out of control there and that you do ultimately require more stimulus here at home," said David Tulk, chief Canada macro strategist at TD Securities.

"Fiscal policy is a better conduit to deliver that support," he said.

Canada's economy has recovered the lost output and jobs from the 2008-09 recession and the Bank of Canada has signaled it might need to start raising interest rates soon. But the economy could take a hit from two different angles - European contagion or a sudden correction in the domestic housing market.

Flaherty told Reuters that he and his colleagues in the Group of Seven industrialized countries were urging their euro zone peers to "... overwhelm the problem and do what they have to do to sort out weaker countries and weaker banks in Europe."

"It's clear what needs to be done. An exercise in political will is needed."

When asked by BNN to rate how unstable Europe was on a scale of one to ten, with ten being the most unstable, Flaherty said most countries are about a "five". "We're not in a full-blown crisis," he said.

Canada's banks have only modest exposure to Europe so any contagion from the crisis there would not be huge and limited to credit tightness, Flaherty said.

The Canadian dollar sank to a four-month low on Friday as investors fretted about a possible Greek exit from the euro.

Flaherty said currency fluctuations on their own were not a big concern for him, as long as the movement was minor.

He welcomed signs that the housing market in Vancouver, the most expensive in Canada, was cooling, but signaled concern that Toronto is still hot.

"It is good to see some moderation. That means that people are paying down their debt more quickly," he said.

"And there's also some moderation in the housing market, which is the major source of indebtedness for most people in Canada - the mortgages on their homes; some moderation on the West Coast in Vancouver. I'm not seeing that kind of moderation in the Toronto market yet."

Canadian home prices climbed 5.2 percent in April from a year earlier, the Canadian Real Estate Association (CREA) said on Friday.

The rise in the industry group's home price index for April compared with a 5.1 percent year-on-year gain in March.

Toronto once again posted the biggest increase with prices jumping 7.9 percent from a year earlier. Prices were up 3.7 percent in Vancouver, compared with a 5.3 percent increase in March.

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