FINANCIAL MARKETS MONTHLY : Waiting for You Know Who pot

We expect that the ECB will maintain its current policy stance and policy rates will remain on hold for the foreseeable future.. That being said, the more likely scenario of a benign fis

December 7, 2012

Waiting for You Know Who

Everyone is waiting for the US political actors to produce a credible and economically viable fiscal policy compromise Financial markets are trying to keep a stiff upper lip anticipating that policymakers will not allow the US economy to slump back into recession Economic data sug-gest that businesses are not as confident about the outcome with investment spending slumping

in the third quarter of 2012 and starting the fourth quarter on shaky footing To be sure, the ef-fect of Hurricane Sandy also weighed on activity with a rebound likely in November and De-cember This pattern was evident in the US auto sales reports with a drop in late October result-ing in monthly sales fallresult-ing below September’s rate only to be followed by a 9% surge in No-vember sales propping them up to the fastest pace since before the recession The nervousness about the US fiscal cliff was also responsible for some of the pullback in Canada with busi-nesses reducing investment and exports dropping sharply in the third quarter The persistently weak data reported for the Euro area economies and the UK are setting these economies on track to contract in the final quarter of the year thereby adding to the nervous tone

US economy to ease out of 2012

US economic growth was revised higher for the third quarter of 2012 with the initial print of 2.0% boosted to 2.7% in the latest update The biggest contributors to this increase were a larger building of inventories and faster export growth Conversely, the update showed a slower in-crease in consumer spending and weaker business investment Given that the upgrade to the

Inside

Overview

……… page 1

Interest rate outlook

……… page 5

Economic outlook

……… page 6

Currency outlook

……… page 7

Central bank watch

……… page 8

What’s in store for

2013-2014

Dawn Desjardins

Assistant Chief Economist

416-974-6919

dawn.desjardins@rbc.com

David Onyett-Jeffries, CFA

Economist

416-974-6525

david.onyett-jeffries@rbc.com

Central bank near-term bias

Bias three-months out

The BoC left the overnight rate at 1.00% and maintained its tightening bias in December We expect the Bank to maintain the current level of policy accommodation to insulate the econ-omy from downside risks coming from abroad

We expect that the Fed will maintain its current policy stance with the fed funds target at 0% to 0.25% and purchases of Treasury bonds and MBS continuing

Skepticism about the effectiveness of additional asset pur-chases and an unwillingness to reduce rates further means that the Funding for Lending Scheme has become the MPC’s pre-ferred policy tool No further changes to policy are expected Recent political developments and earlier actions by the ECB have helped diminish the downside risks to the outlook We expect that the ECB will maintain its current policy stance and policy rates will remain on hold for the foreseeable future The RBA cut the OCR by 25bp to 3.00% in December We expect another 25bp cut in Q2/13, with the OCR then remain-ing on hold at 2.75% for the rest of 2013

The December RBNZ meeting resulted in no changes to pol-icy, and our base case remains that the current 2.50% Official Cash Rate will be maintained during 2013

Financial market volatility

spikes as investors worry

about the global recovery

Data reports have erred

on the weak side

However there were many

one-off factors that

cur-tailed activity

As these factors ease,

growth will accelerate

The US recession was

deeper than was previously

reported and GDP output

stands 0.4 pp below its

pre-recession peak

Highlights

third-quarter 2012 growth rate was largely accounted for by the greater build in invento-ries while domestic demand slowed, it is likely that inventoinvento-ries will be run down in the fourth quarter When the effect of Hurricane Sandy and the uncertainty about the fiscal cliff are factored in, the US economy is likely to end 2012 growing at a sub-par 1.4% annualized pace

2013: a slow start

We assume that US policymakers will be able to reach a compromise on fiscal policy that limits the direct hit to the economy in 2013 to just over 1 percentage point, which is much less than the potential damage that the current legislation implies Having said that, our forecast still builds in fiscal restraint with the biggest drag likely to occur early

in 2013 when payroll taxes and income taxes on high earners increase Spending cuts are likely to be spread out during 2013 The scenario suggests that consumer spending will remain modest early next year due to the reduction in disposable income while business investment picks up its pace given the reduced likelihood that the US economy

is heading back into recession Our forecast is that the US economy will grow at a 2.0% pace in the first quarter of 2013

followed by sustained improvement

Aside from all the fears about the fiscal cliff, economic fundamentals are supportive for the US economy to shift into a higher gear Interest rates are low, and the Fed has clearly stated its intention to provide ample stimulus to the economy for the foreseeable future Corporate balance sheets are healthy, households have made significant headway in put-ting their financial houses in order, and the housing market has emerged from its six-year slump Senior loan officers at financial institutions, in a recent survey by the Federal Re-serve, indicated that on balance lending conditions on loans to small and large companies eased again Demand for loans, outside of commercial real estate, conversely fell as corpo-rations watched to see how the fiscal outlook would play out Going forward, the in-creased availability of funds and low borrowing costs, in our view, will provide a solid boost to investment Additionally, as the weight of uncertainty lifts, we expect that hiring will accelerate therein providing a much-needed boost to consumption Our forecast for the US economy is for growth to accelerate steadily in 2013 with this momentum carrying

on in 2014 We project real GDP growth of 2.3% in 2013 and 3.1% in 2014

Fed remains firmly committed to ‘low for long’

The US Federal Reserve continues to expand both its balance sheet and the set of tools

it is willing to use to foster stronger economic growth and a reduction in the unemploy-ment rate The combination of a commitunemploy-ment to keeping the fed funds target rate

‘exceptionally’ low and its open-ended asset purchase plan have contributed to main-taining accommodative financial conditions In the near term, financial markets will focus on fiscal, rather than monetary, policy Should the worst case scenario play out, the Fed would likely become even more aggressive in pushing interest rates lower That being said, the more likely scenario of a benign fiscal policy outcome means that the Fed will maintain its current policy stance at least until late 2013 when a stronger growth backdrop is likely to see the Fed stop purchases of new securities although con-tinuing to reinvest the proceeds of maturing securities This will signal that the Fed is looking to temper its ultra-easy policy stance

The Fed’s commitment to the low for long interest rate policy will keep short-term rates locked in a range in 2013 Longer-term rates will also remain historically low; however,

as the pace of US Treasury purchases slows in the second half of 2013 and the pace of economic activity accelerates, 10-year and long-bond rates are forecasted to drift higher

Markets waiting for US

government policymakers to

reach a deal that does not

derail the economy

Our forecast assumes that

the fiscal cliff is avoided and

the hit to the economy is

modest in 2013

Once the threat of a

re-turn to recession is

extin-guished, economic growth

will accelerate and be

sup-ported by easy financial

con-ditions

The Fed is committed to

keeping monetary policy

suf-ficiently easy to promote a

strengthening in economic

activity and drive the

unem-ployment rate lower

Canada’s economy put in

a disappointing performance

in the third quarter of 2012 with exports sagging and businesses pulling back

Temporary disruptions in some industries weighed on exports and contributed to the weakening

The end of these tempo-rary shutdowns is teeing the economy up for a firmer fourth quarter

2013 is likely to see Can-ada’s economy regain its stride

The Bank of Canada has maintained a 1.0% policy rate for more than two years and will keep policy accom-modative until there is a clearer trajectory for the global economy

Highlights

Canada: an unsatisfying third quarter

The economy grew at a paltry 0.6% annualized pace in the third quarter of 2012 as

busi-nesses pulled back and exports slumped Some of the weakness was due to disruptions

in energy production that made its way into reduced exports Additionally, the pall on

the US economy from the fiscal cliff reduced demand for Canadian exports while at the

same time led Canadian companies to stand back from investing lest the US economy

slide back into recession Canadian consumer spending rose at a solid clip in the quarter

thereby preventing a more dramatic weakening with the consumption of services

recov-ering after a soft second quarter Inventory levels rose to buttress the third quarter

growth rate at the expense of the fourth quarter when these stocks are likely to be

drawn down

….and a soft hand off to the fourth quarter

The monthly GDP reports underlying the quarter were disappointing with activity

fal-ling in both August and September In August, mining and energy sector output dropped

by 0.9% that reflected maintenance shutdowns While these sectors saw output fall at a

slower pace in September, our expectation is that greater strength will emerge in the

fourth quarter of 2012 by boosting both output in the sector and reversing the drag on

growth from exports The unchanged GDP in September set the fourth quarter on a

slower trajectory than we previously anticipated, yet an expected rebound in exports and

modestly faster business investment still point to the economy expanding at a 2.2%

an-nualized pace

2013 prospects brighter

In 2013, Canada’s economy is forecasted to return to a firmer growth path with business

investment and exports getting a lift as the uncertainties associated with the US fiscal

cliff dissipate Domestic financial conditions are supportive for business investment

while the persistent low interest rate environment will limit the correction in the housing

market Consumer spending is also likely to remain solid given the healthy labour

market and the prospect of wage gains accelerating Government restraint will be

limited compared to most other countries After experiencing a volatile and highly

uncertain 2012, we expect Canada’s economy to grow by 2.4% in 2013 and 2.8% in

2014 This forecast implies that the output gap will be eliminated in early 2014

1% and holding until the second half of 2013

The Bank of Canada left the overnight rate at 1.00% in early December, which is where

it has been since September 2010 The forward-looking guidance from the Bank

remained intact with a gradual withdrawal of stimulus still in the cards as the slack in

the economy is absorbed The statement acknowledged that Canada’s near-term

economic momentum is slower than expected and that the global outlook is “vulnerable

to major shocks from US or Europe” The Bank’s assessment that inflation will return

to the 2% target over the next 12 months, however, implies that policymakers view the

recent slowing in Canadian growth as a short-term hiccup As such, we expect the Bank

to be in position to raise the overnight rate in the third quarter of 2013 and maintain a

gradual pace of reducing stimulus We look for the policy rate to stand at 1.5% at the

end of 2013 and 2.0% at the end of the 2014 Longer-term interest rates will take their

cue from the rise in the domestic policy rate as well as remaining strongly correlated to

the increase in US Treasury yields

Recent data point to

the recession in the euro

area extending at least

through year-end 2012

RBC trimmed growth

forecasts for 2012 and

2013

Near-term growth has

been revised lower in

the UK, but questions

about the efficacy of

asset purchases mean

that policy will likely

remain on hold

Below-trend growth in

Australia supports recent

decisions to cut the

OCR, and we expect a

further 25 basis point

cut to come in the

sec-ond quarter of 2013

Highlights The rumours are true: euro area officially in a recession

The release of the third-quarter 2012 national accounts for the aggregated euro area made it offi-cial that the region fell back into a technical recession because real GDP declined by a non-annualized 0.1% after the 0.2% contraction recorded in the second quarter Moreover, recent indications are that the downward trend in activity evident thus far in 2012 may be intensifying in the current quarter, with the November PMI data suggesting that the recession is likely to con-tinue to at least year-end 2012 We lowered our fourth-quarter growth forecast to a non-annualized -0.2% (from a flat reading previously), thereby resulting in real GDP for the 2012 as a whole declining by 0.4% to mark the first annual contraction since 2009 Our forecast for growth

in 2013 (revised down to a mere 0.1% from 0.4% previously) is contingent on conditions stabi-lizing in the first quarter of 2013; should a stabilization not materialize, it would not likely take much in the way of downside economic news to cause growth in the euro area to turn negative again in 2013 Recent political developments have combined with the earlier actions of the Euro-pean Central Bank (ECB) to help diminish the downside risks to the outlook Without material deterioration to the outlook, we expect that the ECB will maintain its current policy stance and policy rates will remain on hold for the foreseeable future

UK outlook dims as Olympics become distant memory

After receiving an Olympic-sized boost in the summer that helped pick it up and out of recession

in the third quarter of 2012, the UK is now left to face a less jubilant economic reality Early indi-cators of activity in the current quarter point to underlying growth that remains sluggish at best Taking into account some payback from the one-off factors that elevated growth in the previous quarter, we now expect real GDP to contract by a non-annualized 0.1% in the fourth quarter (downwardly revised from 0.3%), while growth in the first quarter of 2013 is now expected to be modest 0.2% (compared to 0.3% previously) The Bank of England’s Monetary Policy

Commit-tee (MPC) likewise revised downward its near-term outlook in the November Inflation Report

while also noting that the risks to the outlook have shifted materially to the downside The MPC also revised upward its forecast for inflation in the near-term, although it remained broadly un-changed in the policy-relevant medium term The minutes from the November MPC meeting again showed that members questioned the efficacy of further asset purchases in boosting domes-tic demand, suggesting that the inflationary risks associated with more quantitative easing are currently viewed as outweighing the economic benefits Given this scepticism and that the MPC

is “unlikely to wish to reduce Bank Rate in the foreseeable future,” it appears as if the Funding for Lending Scheme (FLS) has become the policy tool of choice We now anticipate that the MPC will sit on the sidelines and watch to see if the FLS has a significant effect on demand; early indications are supportive of it helping to improve overall credit conditions

RBA to cut deeper as growth slows

The surprise decision by the Reserve Bank of Australia (RBA) to leave interest rates unchanged in November ended up being just a brief pause in the policy easing cycle as the central bank cut the Official Cash Rate (OCR) by 25 basis points to 3.00% in December The case for further policy accommodation has grown on indications that the economy shifted to a below-trend pace of growth

in the second half of 2012 as the void left by slowing business investment from the natural resource sector is not being adequately filled by other areas of the economy The third-quarter 2012 national accounts data showed that overall GDP growth in the quarter moderated to its lowest rate since natural disasters wreaked havoc on the country in the first quarter of 2011 Our expectation of sof-tening labour markets and slowing income growth will likely limit residential investment and con-sumption from picking up the slack after capital expenditure peaks in 2013, meaning that below-trend growth will likely continue While the RBA hinted that it may move to the sidelines and as-sess the effect of its cumulative 175 basis points worth of cuts to date, we believe that further ac-commodation is warranted We expect that the OCR will be cut further to 2.75% in the second quarter of 2013 and remain at this level for the remainder of 2013

%, end of period

Central bank policy rate

%, end of period

Source: Bloomberg, Reuters, RBC Economics Research

* Two-year/10-year spread in basis points **New Zealand’s yield curve: 10-year vs three-year

Source: Reuters, RBC Economics Research

Current Last

Current Last United States Fed funds 0.0-0.25 1.00 Dec 16, 2008

Canada Overnight rate 1.00 0.75 Sep 8, 2010

United Kingdom Bank rate 0.50 1.00 Mar 5, 2009

11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2

Canada

Overnight 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.25 1.50 1.50 1.75 Three-month 0.80 1.10 0.92 0.88 0.90 1.05 1.05 1.10 1.25 1.50 1.55 1.80 Two-year 0.88 1.00 1.20 1.03 1.15 1.05 1.10 1.40 1.65 1.90 2.10 2.25 Five-year 1.39 1.50 1.56 1.25 1.35 1.30 1.45 1.75 1.95 2.15 2.40 2.55 10-year 2.15 2.30 2.11 1.74 1.75 1.75 1.85 2.15 2.35 2.45 2.60 2.75 30-year 2.77 3.10 2.64 2.33 2.40 2.40 2.45 2.60 2.75 2.95 3.05 3.20

United States

Fed funds 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 Three-month 0.02 0.05 0.07 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 Two-year 0.25 0.30 0.34 0.25 0.25 0.25 0.25 0.25 0.35 0.45 0.65 0.85 Five-year 0.96 1.10 1.04 0.70 0.72 0.70 0.85 0.90 1.05 1.20 1.40 1.50 10-year 1.92 2.15 2.20 1.60 1.65 1.70 1.95 2.10 2.25 2.40 2.55 2.65 30-year 2.92 3.20 3.32 2.70 2.80 2.90 3.25 3.45 3.60 3.85 3.95 4.00

United Kingdom

Bank rate 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 Two-year 0.60 0.70 0.43 0.40 0.20 0.20 0.20 0.20 0.30 0.30 0.30 0.30 10-year 2.44 2.45 2.00 1.80 1.70 1.70 1.75 1.80 2.00 2.00 2.00 2.25

Eurozone

Refi rate 1.50 1.00 1.00 1.00 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 Two-year 0.66 0.65 0.09 0.10 0.00 0.00 0.10 0.15 0.20 0.25 0.30 0.30 10-year 1.90 2.20 1.61 1.50 1.50 1.50 1.60 1.70 1.85 2.00 2.00 2.10

Australia

Cash target rate 4.75 4.25 4.25 3.50 3.50 3.00 3.00 2.75 2.75 2.75 2.75 2.75 Two-year 3.63 3.15 3.49 2.46 2.49 2.75 2.60 2.60 2.70 2.80 2.90 3.00 10-year 4.22 4.05 4.10 3.04 2.94 3.00 3.25 3.30 3.45 3.60 3.75 3.90

New Zealand

Cash target rate 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.50 2.75 3.00 Three-year 2.88 2.85 3.11 2.37 2.55 2.60 2.70 2.70 2.80 2.90 3.00 3.20 10-year 4.39 4.25 4.17 3.40 3.57 3.80 4.00 4.10 4.25 4.50 4.70 4.80

Yield curve

United States 167 185 186 135 140 145 170 185 190 195 190 180 United Kingdom 184 175 157 140 150 150 155 160 170 170 170 195

New Zealand 151 140 106 103 102 120 130 140 145 160 170 160

Economic outlook

Inflation tracking

Source: Statistics Canada, Bureau of Labor Statistics, Bank of England, European Central Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, RBC Economics Research

Source: Statistics Canada, US Bureau of Labor Statistics, Bank of England, European Central Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, RBC Economics Research

1 Seasonally adjusted measurement.

2 Personal consumption expenditures less food and energy price indices

*Seasonally adjusted annualized rates

Inflation Watch

Current period Three-month trend Six-month trend Canada Bank of Canada core CPI1 Oct 0.1 1.2 1.1 1.2

Measure Period ago Year ago

Growth outlook

% change, quarter-over-quarter in real GDP

11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 2011A 2012F 2013F 2014F

United Kingdom 0.5 -0.4 -0.3 -0.4 1.0 -0.1 0.2 0.4 0.5 0.5 0.5 0.5 0.9 -0.1 1.3 2.1

Inflation outlook

% change, year-over-year

11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 2011A 2012F 2013F 2014F

RBC Economics outlook compared to the market

Source: Bloomberg, RBC Economics Research

Level, end of period

Rates are expressed in currency units per US dollar and currency units per Canadian dollar, except the euro, UK pound, Australian dollar, and New Zealand dollar, which are expressed in US dollars per currency unit and Canadian dollars per currency unit.

The following charts track historical exchange rates plus the forward rate (dashed line) compared to the RBC Economics forecast (dotted line) out one year The cone for the forecast period frames the forward rate with confidence bounds using implied option volatilities as of the date of publication.

11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 Canadian dollar 0.97 0.96 1.05 1.02 1.00 1.02 0.98 0.99 0.98 0.96 0.95 0.94 Euro 1.42 1.45 1.34 1.30 1.33 1.27 1.29 1.32 1.28 1.25 1.23 1.22 U.K pound sterling 1.60 1.61 1.56 1.55 1.60 1.57 1.62 1.65 1.62 1.60 1.60 1.63 New Zealand dollar 0.76 0.83 0.76 0.78 0.82 0.80 0.83 0.82 0.81 0.79 0.77 0.77 Japanese yen 83.1 80.6 77.0 76.9 82.9 79.8 77.9 77.0 75.0 72.0 71.0 70.0 Chinese renminbi 6.55 6.46 6.38 6.30 6.29 6.36 6.29 6.30 6.25 6.20 6.15 6.15 Australian dollar 1.03 1.07 0.97 1.02 1.03 1.02 1.04 1.06 1.04 1.02 1.00 1.00 Mexican peso 11.9 11.7 13.9 14.0 12.8 13.4 12.9 12.8 12.8 12.7 12.5 12.3

Canadian dollar cross-rates

11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q2 13Q3 13Q4 EUR/CAD 1.37 1.40 1.41 1.32 1.33 1.29 1.26 1.31 1.25 1.20 1.17 1.15 GBP/CAD 1.56 1.55 1.64 1.59 1.60 1.60 1.59 1.63 1.59 1.54 1.52 1.53 NZD/CAD 0.74 0.80 0.80 0.79 0.82 0.81 0.82 0.81 0.79 0.76 0.73 0.72 CAD/JPY 85.6 83.6 73.3 75.3 83.0 78.5 79.2 77.8 76.5 75.0 74.7 74.5 AUD/CAD 1.00 1.03 1.01 1.04 1.03 1.04 1.02 1.05 1.02 0.98 0.95 0.94

Forecast Actuals

Canadian dollar

0.80

0.90

1.00

1.10

1.20

Nov-11 May-12 Nov-12 May-13

Euro

1.00 1.10 1.20 1.30 1.40 1.50 1.60 1.70

Japanese yen

66

76

86

96

Nov-11 May-12 Nov-12 May-13

U.K pound

1.20 1.40 1.60 1.80 2.00

Central bank watch Bank of Canada

Federal Reserve

European Central Bank

Bank of England

Australia and New Zealand

• Canadian real GDP growth slowed to an

an-nualized 0.6% in Q3/12 from 1.7% in Q2/12 as

weakness in exports and business investment

weighed on economic output

• We expect the BoC to be in position to raise

rates in Q3/13 and maintain a gradual pace of

reducing stimulus, with the overnight rate ending

2014 at 2.00%

• US Q3/12 real GDP growth was revised

up-ward to an annualized 2.7% from 2.0% reflecting

higher inventories and stronger exports tempered by

weaker spending by consumers and businesses

• The Fed is committed to keeping monetary

policy highly accommodative to support a

strength-ening in growth and drive the unemployment rate

lower

• Early indicators of activity in the current

quarter point to underlying growth that remains

sluggish at best, and we now expect real GDP to

contract by 0.1% on a non-annualized in Q4/12

• The MPC is unlikely to extend its asset

pur-chase target beyond the current £375 billion,

while rates will remain unchanged over the

fore-cast horizon

• The RBA cut policy rates by 25bp in

Decem-ber, and we expect a further 25bp cut to come in

Q2/13, with the OCR holding at 2.75% until late

2014

• The RBNZ left policy unchanged at its

De-cember meeting, and we continue to expect that

the OCR will remain at its current 2.50% level

through 2013

• The November PMI data suggest that the

recession in the euro area is likely to continue

through to at least year-end 2012

• In the absence of a material deterioration to

the outlook, we expect that the ECB will maintain

its current policy stance and that the policy rate

will remain on hold for the foreseeable future

-10 -8 -6 -4 -2 2 4 6 8

Quarter-over-quarter annualized % change

Canadian real GDP growth

Forecasted values:

Source: Statistics Canada, RBC Economics Research

-10 -8 -6 -4 -2 2 4 6 8

Quarter-over-quarter annualized % change

U.S real GDP growth

Source: Bureau of Economics Analysis, RBC Economics Research Forecasted values:

-3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

% change, quarter-over-quarter Eurozone GDP

Source: Eurostat, RBC Economics Research Forecasted values:

-2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

% change, quarter-over-quarterU.K real GDP growth

Source: Central Statistical Office, RBC Economics Research

0 1 2 3 4 5 6 7

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 BoC overnight rate Fed funds rate

Source: Bank of Canada, Federal Reserve Board, RBC Economics Research

%

Forecast

Canadian and U.S central bank policy rates

0 1 2 3 4 5 6

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

U.S core CPI inflation

Source: Bureau of Labor Statistics, RBC Economics Research

% change, year-over-year

Forecast

0 1 2 3 4 5 6 7

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Bank of England, RBC Economics Research

%

Forecast

U.K policy rate

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Australia New Zealand

% change, quarter-over-quarter

Australia and New Zealand GDP growth

Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research

Forecast

0 1 2 3 4 5 6 7

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Australia New Zealand

% change, year-over-year

Australia and New Zealand inflation

Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research

Forecast

0 1 2 3 4 5 6 7

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: ECB, RBC Economics Research

%

Forecast

ECB refi rate

The material contained in this report is the property of Royal Bank of Canada and may not be reproduced in any way, in whole or in part, without express authoriza-tion of the copyright holder in writing The statements and statistics contained herein have been prepared by RBC Economics Research based on informaauthoriza-tion from sources considered to be reliable We make no representation or warranty, express or implied, as to its accuracy or completeness This publication is for the informa-tion of investors and business persons and does not constitute an offer to sell or a solicitainforma-tion to buy securities

®Registered trademark of Royal Bank of Canada

©Royal Bank of Canada

What’s in store for 2013-2014

the upside on inflation

Monetary policy will remain stimulative, even taking into

ac-count modest rates increases in some ac-countries

Term yields will drift higher although are likely to remain below historical norms

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Canada U.S UK Eurozone Australia New Zealand

2011 2012 2013 2014 year-over-year, % change

Real GDP Growth

Source: International Monetary Fund, RBC Economics Research

1 2 3 4 5

Canada U.S UK Eurozone Australia New Zealand

2011 2012F 2013F 2014F year-over-year, % change

CPI Inflations

Source: Statistics Canada, Bureau of Labor Statistics, Office for National Statistics, Statistical Office of the European Communities, Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research

1

2

3

4

5

6

7

8

9

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Canada U.S.

UK Eurozone Australia New Zealand

%

Central Bank Policy Rates: International

Forecast

Source: Bank of England, European Central Bank, Federal Reserve, Bank of Canada, Reserve Bank of Australia, Reserve

Bank of New Zealand, RBC Economics Research

1 2 3 4 5 6 7

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Canada U.S.

UK Eurozone Australia New Zealand

%

10 year bond yields

Forecast

Source: Bank of Canada , U.S Treasury, Financial Times, Reuters, RBC Economics Research