FINANCIAL MARKETS MONTHLY 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 falling 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 ……………………………… page 9 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. 2 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 inventories 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 commitment 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. 3 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. 4 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. 5 Interest rate outlook %, 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 Eurozone Refi rate 0.75 1.00 Jul. 5, 2012 Australia Cash rate 3.00 3.25 Dec. 5, 2012 New Zealand Cash rate 2.50 3.00 Mar. 10, 2011 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 Canada 127 130 91 71 60 70 75 75 70 55 50 50 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 Eurozone 124 155 152 140 150 150 150 155 165 175 170 180 Australia 599061584525657075808590 New Zealand 151 140 106 103 102 120 130 140 145 160 170 160 Actuals Forecast 6 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 CPI 1 Oct. 0.1 1.2 1.1 1.2 United States Core PCE 2 Oct. 0.1 1.6 0.9 1.5 United Kingdom All-items CPI Oct. 0.6 2.6 3.5 2.1 Eurozone All-items CPI Oct. 0.1 2.5 3.7 2.1 Australia Trimmed mean Q3 0.7 2.4 N/A N/A New Zealand CPI Q3 0.3 0.8 N/A N/A Measure Period ago Year ago Growth outlook % change, quarter-over-quarter in real GDP 11Q3 11Q4 12Q1 12Q2 12Q3 12Q 4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 2011A 2012 F 2013 F 2014F Canada* 5.8 2.1 1.7 1.7 0.6 2.2 2.4 2.7 3.4 3.2 2.9 2.2 2.6 2.0 2.4 2.8 United States* 1.3 4.1 2.0 1.3 2.7 1.4 2.0 2.7 3.0 3.3 3.0 3.0 1.8 2.2 2.3 3.1 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 Eurozone 0.1 -0.3 0.0 -0.2 -0.1 -0.2 0.0 0.2 0.3 0.3 0.3 0.3 1.5 -0.4 0.1 1.0 Australia 1.1 0.5 1.3 0.6 0.5 0.5 0.6 0.7 0.9 0.8 0.8 0.7 2.4 3.6 2.5 3.0 New Zealand 0.4 0.4 1.0 0.6 0.5 0.8 0.8 0.8 0.7 0.7 0.7 0.6 1.2 2.6 3.0 2.7 Inflation outlook % change, year-over-year 11Q3 11Q4 12Q1 12Q2 12Q3 12Q 4 13Q1 13Q2 13Q3 13Q4 14Q1 14Q2 2011A 2012F 2013F 2014F Canada 3.0 2.7 2.4 1.6 1.2 1.2 1.2 1.5 1.9 1.9 1.9 1.9 2.9 1.6 1.7 2.0 United States 3.8 3.3 2.8 1.9 1.7 1.9 1.4 1.7 1.7 1.8 1.9 1.9 3.2 2.0 1.7 1.9 United Kingdom 4.7 4.7 3.5 2.8 2.4 2.6 2.3 2.5 2.5 2.3 2.3 2.3 4.5 2.8 2.4 2.3 Eurozone 2.7 2.9 2.7 2.5 2.5 2.4 2.0 2.0 1.9 1.9 1.8 1.8 2.7 2.5 2.0 1.7 Australia 3.5 3.1 1.6 1.2 2.0 2.7 3.4 3.6 2.9 2.9 2.8 2.8 3.3 1.9 3.2 2.9 New Zealand 4.6 1.8 1.6 1.0 0.8 1.3 1.2 1.4 1.7 1.9 1.9 1.8 4.0 1.2 1.5 1.8 7 Currency outlook 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. poun d ster l ing1.601.611.561.551.601.571.621.651.621.601.601.63 New Zea l an d d o ll ar 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 C h inese renmin b i 6.556.466.386.306.296.366.296.306.256.206.156.15 Austra l ian d o ll ar 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 1.371.401.411.321.331.291.261.311.251.201.171.15 GBP/CAD 1.561.551.641.591.601.601.591.631.591.541.521.53 NZD/CAD 0.740.800.800.790.820.810.820.810.790.760.730.72 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 1.001.031.011.041.031.041.021.051.020.980.950.94 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 Nov-11 May-12 Nov-12 May-13 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 Nov-11 May-12 Nov-12 May-13 8 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 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Quarter-over-quarter annualized % change Canadian real GDP growth Forecasted values: Source: S tatistics Canada, RBC Economics Research -10 -8 -6 -4 -2 2 4 6 8 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Quarter-ov er-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-quarter U.K. real GDP growth Source: Central Statis tical 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-ov er-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-ov er-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 9 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 information 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 solicitation to buy securities. ®Registered trademark of Royal Bank of Canada. ©Royal Bank of Canada. What’s in store for 2013-2014 As global uncertainties fade, economic growth will accelerate. Spare capacity created during the economic downturn will cap the upside on inflation. Monetary policy will remain stimulative, even taking into ac- count modest rates increases in some 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 . FINANCIAL MARKETS MONTHLY December 7, 2012 Waiting for You Know Who Everyone is waiting for the US political actors to. are forecasted to drift higher. Markets waiting for US government policymakers to reach a deal that does not derail the economy. Our forecast