OTTAWA, Feb 26 (Reuters) - Canadian Finance Minister Bill Morneau is expected to unveil a restrained budget on Tuesday, with just enough spending to assuage middle class voters under pressure from rising rates -- while keeping his powder dry amid uncertainty over NAFTA.
With the domestic economy going strong and the Bank of Canada hiking rates, the Liberal government is in a balancing act of slowly reining in deficits while taking steps to bolster long-term growth as U.S. tax cuts and protectionism threaten Canadian exports and competitiveness.
Household debt is also at a record high even as job gains bring the country closer to full employment, a bad news-good news dichotomy that will leave the government wanting to rebuild its rainy day cushion without abruptly withdrawing stimulus.
"Canada at this juncture is an incredible risk management exercise," said Frances Donald, senior economist at Manulife Asset Management.
"From my perspective, a stay-the-course budget that keeps gunpowder aside for future downside shocks could be just as well received -- or better -- than a budget focused on spending."
In its October update, the government estimated the deficit at C$19.9 billion ($15.71 billion) for the fiscal 2017-18 year ending March 31, down from the C$28.5 billion anticipated in last year's budget.
For the upcoming 2018-19 fiscal year, the deficit is seen at C$18.6 billion, including C$3 billion for risk adjustment.
While the next federal election is not until October 2019, giving the Liberals another chance to deliver a vote-grabbing budget, the economy faces some risks, including a possible end to the North American Free Trade Agreement (NAFTA) or a sharp downturn in the housing market.
Morneau's third budget is expected to include relatively low-cost goodies for women and indigenous communities, consistent with an agenda of boosting gender parity and inclusion. Such measures could also be funded through reallocated infrastructure money.
Economists said there is less need for the government to continue to spend -- and a risk that more spending would force the central bank to hike rates faster than it otherwise would.
"This is really the point where you should be thinking about fiscal tightening," said senior economist Brian DePratto at TD Economics. "You wouldn't try to rush more money out the door necessarily at this point."
While Canada could consider changing the tax rate on capital investment in light of the recent reduction in U.S. corporate taxes, Morneau is unlikely to unveil massive changes at this point, said Nathan Janzen, senior economist at Royal Bank of Canada. ($1 = 1.2665 Canadian dollars) (Reporting by Leah Schnurr; Editing by Sandra Maler)