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Amid a strong economic recovery from the pandemic, Canada is retaining its “AAA” credit rating, DBRS Inc. says in a new report.

While government finances were battered by the extraordinary fiscal support provided to help households and businesses weather the pandemic, the economy rebounded strongly and output returned to pre-pandemic levels in the fourth quarter of 2021, the rating agency noted.

“Activity may have slowed in early 2022 due to the omicron variant, but we expect the impact to be mild and short-lived given that new Covid-19 cases were sharply down by February and most provinces have already lifted restrictions,” DBRS said.

Additionally, the near-term economic outlook is relatively positive. Pent-up demand and consumer spending is driving activity, and supply constraints are expected to ease gradually this year.

“The IMF projects GDP growth of 4.1% in 2022 and 2.8% in 2023,” DBRS noted.

Against this backdrop, monetary policy is starting to tighten, given the lack of slack in the economy. “Policy tightening should moderate aggregate demand, reduce inflation pressures, and potentially help to cool a red-hot housing market,” DBRS noted.

Given the strong recovery and the withdrawal of temporary fiscal supports, government finances are also expected to improve.

“The federal fiscal deficit is expected to decline from 14.6% of GDP in [fiscal 2020-2021] to just 2.2% in [fiscal 2022-2023],” DBRS said, adding that recent provincial budgets also indicate that government finances at that level are improving too.

Looking ahead, the rating agency expects the government debt ratio “to be on a firm downward trajectory.”

Despite the generally positive outlook, risks are generally on the downside.

“The pandemic could continue to disrupt supply and weigh on the recovery. In addition, the conflict in Ukraine adds considerable risk to the global outlook,” DBRS said. “Canada may benefit from higher commodity export prices, but escalating geopolitical tensions could also materially weaken demand from key trading partners, worsen existing supply chain disruptions, and add to inflation pressures.”