Published December 12, 2023

It's the economy, stupid: How high inflation and interest rates tanked the Liberals

By Nojoud Al Mallees in Ottawa

Justin Trudeau's government has had to weather many storms over the last eight years.

The SNC-Lavalin controversy. An old yearbook photo with the prime minister in blackface. Multiple ethics violations. The COVID-19 pandemic.

But as the governing Liberals continue to slide in the polls, the slow-moving hurricane that may actually end up blowing them away appears to be the economy.

For many, the pandemic has receded into little more than a bad memory. But the economic domino effect it touched off lingers on, wreaking electoral havoc on incumbent governments around the world.

High inflation and interest rates have left people feeling worse off, even as the Canadian economy outperforms expectations in many ways.

Polls suggest the governing party is badly trailing the Conservatives. Cost-of-living issues are dominating federal politics and a resurgent Tory party is placing the blame for the erosion of affordability squarely on Trudeau's shoulders.

When did things start going so wrong for the Liberals?

Support for the Conservatives took off this summer, just as the Bank of Canada began raising interest rates again after pausing its rate-hiking cycle earlier in the year.

"That was when people were starting to cycle through the first wave of mortgage renewals," said Tyler Meredith, a former head of economic strategy and planning for Finance Minister Chrystia Freeland.

Canadians renewing their mortgages this year are seeing higher monthly payments as they pay more in interest to finance their homes. That leaves less money on the table for everything else.

The federal government doesn't actually set interest rates, but data suggest a close correlation between the Bank of Canada's rate hikes and the bottom falling out of public support for the Liberals.

Even before this year's spike, Abacus Data polling at the time suggested the Conservatives first started to overtake the Liberals after the central bank's first post-pandemic rate hike in March 2022.

"I do think that was a turning point," said David Coletto, the CEO of the Ottawa-based polling and market research firm.

A range of polling indicators have turned against the Liberals since then, he added.

For months, the federal government has faced relentless scrutiny, partisan and otherwise, for its perceived role in the affordability crisis.

Some economists accused Ottawa of spending too much in the face of soaring inflation, during a time when they said fiscal policy needed reeling in.

Housing advocates, policy experts and economists have also called out the Liberals for mismatched housing and immigration policies.

They argue that rapid population growth amid constrained housing supply compounded the effect of higher interest rates on affordability.

But much of what the Liberals are experiencing is also a global phenomenon. Inflation has ravaged economies around the world, pushing central banks to aggressively raise interest rates and turning voters against incumbent governments.

Inflation is now falling in many of the same countries. Yet incumbent leaders are still struggling.

In the United States, President Joe Biden is near an all-time low in his approval rating. There, the inflation rate was 3.2 per cent in October, while the Federal Reserve's benchmark interest rate sits at about 5.4 per cent, the highest level in 22 years.

In the United Kingdom, Conservative Prime Minister Rishi Sunak's approval rating has also plunged to a record low — even lower than that of Liz Truss, who had to resign after only 49 days in office.

The U.K.'s inflation rate was 4.6 per cent in October, while the Bank of England's benchmark interest rate sits at 5.25 per cent.

In the Netherlands, inflation has fallen by a lot since peaking above 14 per cent last year. But concerns over immigration — and its perceived impact on affordability — led to the demise of a four-party coalition government in the summer.

The far-right Party for Freedom won the most seats in an election last month. Its leader, Geert Wilders, ran an anti-immigration campaign that was also focused on the cost of living.

"Inflation's a cancer on government popularity, and there's no easy treatment," Coletto said.

Indeed, the treatment has been punishing in its own right. Central banks have responded to high inflation with hefty interest rate hikes that have made it more expensive for consumers and businesses to borrow money.

The Bank of Canada's key interest rate currently sits at five per cent, the highest it has been since 2001.

The pullback in spending has slowed the Canadian economy this year and pushed up the unemployment rate, trends that are expected to continue in 2024.

At the same time, Canada's economy has done much better than economists have expected over the last couple of years. It bounced back after the pandemic, pushing the unemployment rate to a near all-time low of 4.9 per cent in the summer of 2022.

The country has also skirted a recession so far, contrary to many forecasts. And inflation is 3.1 per cent, down significantly from last year's breathtaking highs.

Yet people still feel down about the economy — a phenomenon Meredith described as a "vibe-cession."

"To a lot of people, it looks and feels like a recession, even though we're not actually in a recession yet," he said.

The political challenge for the Liberals is finding a way to bridge the disconnect between negative public sentiment and the truth about the economy, Meredith added.

Meanwhile, Conservative Leader Pierre Poilievre's aggressive yet simple cost-of-living message has been catching fire online. His 15-minute video about the housing crisis garnered millions of views on social media since it was released earlier this month.

The explainer-style video, which uses graphics and statistics to illustrate the scale of the housing crisis, argues that Canada's housing affordability crisis has a simple cause: Trudeau himself.

But it's too early to conclude that it's over for the the Liberals, said Meredith, noting that a lot can happen between now and the next election. That contest is scheduled to take place by fall 2025, though it could be called before then.

On the economic front, things are supposed to look different by that time.

Most economists anticipate inflation will return to two per cent by 2025, while the central bank is expected to start cutting rates sometime next year.

Lower interest rates would signal a better outlook for the economy, but that won't necessarily mean lower mortgage costs for everyone.

The central bank has been signalling that interest rates may not return to pre-pandemic levels, even as inflation gets more manageable. That means many Canadians will continue to renew their mortgages at higher interest rates, even as rates fall.

As for inflation, Canadians are stuck with higher prices, even if the pace of price growth comes back down to two per cent.

Given the anxieties people are feeling about the costs they're facing, Meredith said the Liberals need a different economic message.

"If we say, 'jobs and growth' — which has often been a mantra that the government has repeated — I'm not sure that means anything to anybody," he said.

"To get over that, you have to get in front of the issue and say, 'Here's what we're doing to lower costs for you.'"

Banner image: THE CANADIAN PRESS/Sean Kilpatrick

This report by The Canadian Press was first published Dec. 12, 2023.

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