Happy New Year? - RBC.com

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Jan 8, 2016 - cluding manufacturing, wholesale, and retail trade. ... the Canadian dollar as low as US$0.69 by the end o
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FINANCIAL MARKETS MONTHLY January 8, 2016

Happy New Year? Overview ………………………………...page 1 Interest rate outlook ………………………………...page 5 Economic outlook ………………………………...page 6

Investors entered 2016 with a bad case of the jitters, as indicated by the 2% drop in the MSCI world stock index on the first day of trading. The combination of geopolitical concerns and a run of weaker than expected data-fuelled anxiety about the ability of the world economy to recover following 2015’s subpar performance. This contributed to further downward pressure on already low oil prices. The downdraft in equity markets was kicked off by a report showing weakness in the Chinese manufacturing sector persisted in December and continued as data from other countries underperformed expectations. The rout in financial markets continued despite aggressive actions by the Chinese central bank, as investors looked for concrete evidence that the global economy is on a firmer growth track.

Liftoff! Currency outlook ………………………………...page 7 Central bank watch ………………………………...page 8 Markets expecting a rate cut from the BoC by year end ……………….………………..page 9

The Federal Reserve met market expectations raising the range for the fed funds rate by 25 basis points to 0.25–0.50% at its December 2015 meeting. The much-anticipated hike came seven years to the day after rates were first lowered to emergency levels during the financial crisis. Some expected it would be a ‘dovish’ hike accompanied by a downward revision to Federal Open Market Committee (FOMC) members’ projections of future rate increases. That was not the case, however, as policymakers continue to expect 100 basis points of hikes in 2016 and left the longer-run neutral rate unchanged at 3.50%. On balance, financial markets took the announcement in stride with Treasury yields rising just a few basis points on the day while the S&P 500 rose 1.5%.

Central bank near-term bias Three-months out, policy rate BoC Governor Poloz gave a few hints on monetary policy in a recent speech but a cautiously optimistic tone seemed to indicate the Bank is in “wait and see” mode. We expect a steady rate decision on January 20, 2016. We expect the Fed will continue its gradual withdrawal of stimulus with 25 basis point rate hikes each quarter in 2016, a pace that would be consistent with the latest FOMC projections. Inflation is expected to jump higher in Q1/16 due to a smaller drag from energy prices but will accelerate only slightly during the rest of 2016, thereby putting little pressure on the BoE to tighten policy despite limited slack in the economy.

Josh Nye Economist 416-974-3979 [email protected]

Dawn Desjardins Deputy Chief Economist 416-974-6919 [email protected]

Despite failing to impress markets with added stimulus in December, we expect the ECB will keep policy on hold in the near term albeit with a more dovish tone than the previous meeting. We continue to expect easier monetary policy will be required in 2016. Our forecast assumes the RBA’s drawn-out easing cycle will resume in Q1/16, although the risk is that rates are held steady early in the year. The RBNZ cut rates for the fourth time in 2015 in December and signalled that further easing is unlikely. We expect the cash rate will be held at its current record low of 2.50% throughout 2016.

Highlights

Financial conditions will remain accommodative

spikes as investorshike worry  A long-awaited from about the global recovery. the Fed caused only minor

Financial markets expect the Fed to conduct a very slow tightening cycle with only two hikes priced in 2016. Our forecast is more aligned with the Fed’s projection, and we expect 25 basis point hikes will be announced each quarter in 2016. Even our more aggressive call still denotes a modest trajectory of rate increases that we expect will limit the pickup in longer-term rates as well. We expect the yield on 10-year Treasuries to rise to just over 3.00% by the end of 2016 from 2.20% currently. Thus even with the hiking cycle now underway, we expect financial conditions will remain sufficiently accommodative to support consumption and investment activity throughout 2016.

moves in financial markets.

Growth likely slowed in the final quarter of 2015





Financial market volatility

Data reports have erred

on weak tightening side.  Athe gradual cycle is expected to keep longerterm rates at accommoda However there were many tive levels. one-off factors that curtailed activity. 

Recent data point to US

GDP growth slipping below  As these factors ease, 2% in Q4/15. growth will accelerate.

The final estimate of third-quarter 2015 gross domestic product (GDP) growth showed a 2.0% annualized gain, which was slower than the second quarter’s 3.9% increase, as the pace of inventory investment weakened. Domestic spending remained strong, growing at a 2.9% rate. The drag from inventories will continue in the fourth quarter albeit at a moderate pace, while recent data point to a softer growth impulse from domestic demand. Construction spending and equipment investment indicate less of a pickup in non -residential investment than in recent quarters, and although consumer spending growth remained solid during the holiday season, it was less robust than the gains seen in the second and third quarters. Auto sales continued at a strong clip in December but slowed relative to the decade-high sales pace recorded in the prior three months. As a result, domestic spending is forecasted to have slowed moderately to 2.0%. Adding in the drag from net trade and inventories, the US economy is expected to have grown at a 1.4% annualized pace in the fourth quarter.

But drivers of expansion remain in place A renewed downturn in The US should recession was oil prices provide  

deeper than was previously additional support to the US reported and GDP output economy. stands 0.4 pp below its prerecession peak.

Despite slight weakening in activity toward the end of 2015, we continue to expect growth will return to an above-trend pace in 2016. Consumer spending is forecasted to remain a significant source of strength, given solid job gains and an expected pickup in wages as labour markets tighten further. Payroll growth averaged 220,000 in 2015 (and an even stronger 281,000 in the fourth quarter), and hiring is expected to continue in 2016 albeit at a slightly more moderate pace as the economy approaches full employment. Further weakness in both oil and gas prices should provide additional support to spending, particularly as expectations of low energy prices become entrenched and households are more willing to spend the savings. Also reflecting those factors, the recovery in housing activity is expected to continue in 2016 amid low interest rates and accommodative lending standards. Solid domestic demand, low energy costs, and growing capacity constraints are likely to fuel a pickup in non-energy business investment, although the oil and gas industry will likely continue to suffer under persistently low energy prices. With broad-based strength in the US economy outside of the energy sector, GDP growth is forecasted to edge upward to 2.5% in 2016 from 2.4% in 2015.

Canadian GDP growth stalled in October Canadian GDP growth was unexpectedly flat in October, thereby disappointing market expectations for a rebound following September’s 0.5% decline that interrupted a streak of three consecutive monthly gains. Expectations for a rebound were partially based on an anticipated recovery in oil and gas extraction, after a temporary fire-related production outage at a major oil sands facility in September. In the event, however, the rebound was smaller than expected and offset by modest declines in other industries including manufacturing, wholesale, and retail trade. The weak start to the fourth quarter pushed our GDP growth forecast downward to flat for the quarter, even with an expected pickup in the final two months of 2015. This slowing is occurring despite signs of strength in domestic demand with auto sales, home sales, and housing starts remaining strong in the fourth quarter. Gains in consumer spending and residential investment are forecasted to offset a slower inventory build and continued contraction in business investment, while net trade is not expected to provide the support to fourth-quarter growth as it did in the third quarter. 2

Bank of Canada likely to take a cautious tone... With the economy remaining flat in October, the Bank of Canada’s most recent growth forecast of 1.5% for the fourth quarter (projected in October) seems out of reach. While it is clear that the fourth-quarter growth forecast will be cut (likely close to zero), markets will be more interested in whether the Bank thinks recent weakness will continue in 2016. The statement following its December meeting highlighted the opposing trends of declining investment in the resources sector and a pickup in non-resource exports. Recently, there has been limited evidence of the latter with a string of weak trade reports from August through October, although November showed tentative signs of improvement. A renewed downturn in oil prices will likely put further downward pressure on energy capex plans for 2016, although the attendant depreciation of the Canadian dollar will likely provide additional support to exporters. The Bank’s updated forecast to be released on January 20, 2016 will detail the relative effects of these developments.

Highlights



Flat overall growth in Oc-

tober 2015 has pushed our Q4/15 growth forecast downward to 0%.

...though no rate cut expected In a speech on January 7, 2016, Governor Poloz reviewed the effect of falling commodity prices on the Canadian economy. While he noted the hit to Canada’s terms of trade is “unambiguously negative,” lower commodity prices are a net positive for the global economy and notably countries like the US and in Europe. Governor Poloz remained cautiously optimistic that the adjustment toward growth in the non-resource economy is underway but emphasized that it will be a slow process. He noted evidence that one of the main offsets to weaker energy sector activity, non-resource exports, is already showing signs of picking up and will be further spurred on by recent depreciation in the Canadian dollar— an important mechanism in the adjustment process. Less than two weeks away from the Bank’s next policy announcement, the Governor steered clear of discussing the near-term monetary policy outlook. His remarks did not suggest that the Bank sees an immediate need to respond to the renewed downdraft in oil prices, and we view the speech as indicating the Bank of Canada is in ‘wait and see’ mode. The Governor stated that the economy’s weak performance in 2015 resulted in a widening in the output gap. In the October Monetary Policy Report, the Bank estimated that the spare capacity in the economy would be eliminated around the middle of 2017. The weaker outturn in the fourth quarter than the Bank expected sets up for the timing of the elimination of the gap to be pushed further into the future. Additionally, the lower starting point for the economy in 2016 will likely result in the Bank inching downward its annual growth forecast. With the output gap likely to persist longer than we (and the Bank ) previously expected, the chances of the Bank reducing policy stimulus this year have fallen. As such, we now look for the Bank to hold the overnight rate at 0.5% until 2017.



Weak data and lower oil

prices are likely to prompt a cautious tone in the BoC’s next policy statement and MPR—both released January 20, 2016.



We expect the Canadian

dollar will fall as low a 69 US cents in Q1/16 before recovering slowly throughout the year.

Weaker CAD providing welcome support The renewed downturn in oil prices put additional downward pressure on the Canadian dollar in the latter part of 2015, with the Fed’s December rate hike adding fuel to the depreciating trend. In mid-December, the price of oil (West Texas Intermediate or WTI) slipped below $35/barrel for the first time since the financial crisis and has been sitting close to that mark to date in 2016. While we continue to expect a rebound in oil prices this year, our forecast now assumes that the average WTI price will remain below $50/barrel for the first half of 2016. Alongside further rate hikes by the Fed, that is expected to push the Canadian dollar as low as US$0.69 by the end of the first quarter, with only a modest recovery to US$0.71 by mid-year. The depreciating trend is expected to reverse somewhat in the second half of 2016, as oil prices recover and the effect of monetary policy divergence begins to lessen. This weaker profile for the Canadian dollar in 2016 should provide welcome support to the domestic economy with improved competitiveness helping exporters take advantage of strong US growth.

3

Highlights 

The ECB is likely to sit

on the sidelines after easing policy in December 2015.

Euro area activity remains solid in Q4 Recent data point to euro area growth rebounding to a 0.4% non-annualized pace in the fourth quarter after unexpectedly slipping to 0.3% in the third quarter. This is supported by survey indicators that for the currency bloc as a whole, marked their strongest quarterly average since mid-2011. Pockets of weakness remain (France’s readings point to further stagnation, although sentiment may have been affected by terrorist attacks in Paris), but the signal for the euro area as a whole has been consistently positive for much of 2015. The slight pick up toward the end of 2015 and solid readings in forward-looking components bode well for momentum to carry into 2016. Inflation remains subdued, however, with the December headline reading holding at 0.2% year over year and falling short of market (and likely European Central Bank or ECB) expectations. Inflation is expected to pick up in January due to base effects from earlier energy price declines; however, the continued shortfall relative to ECB expectations and lack of underlying inflationary pressure could prompt a more dovish stance from the central bank. We expect the ECB will keep policy on hold in the near term to evaluate the effect of recent measures (the extension of asset purchases and deposit rate cut announced in December), although there is room to shift from the current neutral tone.

GDP revisions leave UK growth closer to trend 

UK GDP growth was

revised downward in both Q2 and Q3.



Despite the RBA’s op-

timism, we expect further easing in 2016 as activity disappoints.



The RBNZ is expected

to stay on the sidelines following 100 basis points of cuts in 2015.

4

The third estimate of third-quarter UK GDP growth was revised downward to 0.4% from an earlier reported 0.5% while the second quarter was lowered by an even greater 0.2 percentage points to 0.5%. Recent survey indicators point to growth returning to a 0.5% pace in the fourth quarter of 2015, but there is potential for recent flooding to weigh on the quarterly reading. Any effect is likely to be transitory, however, and should not affect policy. The expected gain in the fourth quarter would leave annual growth for 2015 at 2.2%, closer to trend than the 2.4% gain expected prior to revisions. Inflation returned to positive territory at 0.1% in November and is expected to pick up further in the near term as the effect of earlier energy price declines dissipates; however, we do not expect inflation will rise meaningfully above 1% for much of 2016. We continue to see risks skewed toward a later Bank Rate hike than our current mid2016 forecast, notwithstanding the Fed kicking off its tightening cycle in December. Once again, the outlook for wage growth and thus medium-term inflation remains key to the timing of policy normalization.

RBA ends 2015 with an optimistic tone The Reserve Bank of Australia (RBA) maintained a relatively optimistic tone at its final meeting of 2015, noting that recent data have been positive with low rates working their way through the economy and the exchange rate providing support. Domestic data have remained firm since the December meeting, with solid GDP and employment reports likely reinforcing the central bank’s view. The RBA showed less concern about negative factors such as further weakness in commodity prices, terms of trade, and growth concerns in emerging markets. We continue to expect that those factors will result in softer growth in 2016 and prompt additional easing; however, the reluctance to lower rates further is clear ,and there is a risk that the RBA stays on the sidelines longer than our forecasted first-quarter rate cut.

RBNZ hints latest rate cut will be last of the cycle The Reserve Bank of New Zealand (RBNZ) met market expectations in December by cutting the cash rate by 25 basis points to 2.50% at its final meeting of 2015. The central bank’s updated inflation projections highlighted the need for easier monetary policy. Specifically, the inflation profile was lowered by around half a percentage point for most of the forecast horizon and is not expected to reach the 2% midpoint of the target band until the end of 2017. Some of the downward revision to the inflation projection reflects a stronger New Zealand dollar; however, labour market dynamics (a soft job market and strong net migration) indicate limited inflationary pressure from wages costs. Notwithstanding the subdued inflation profile, RBNZ Governor Wheeler implied the latest cut is likely to be the last of the cycle, noting the current policy stance expected to bring inflation back to target in the medium term. Our forecast similarly assumes the cash rate will be held at its current record low throughout 2016.

Interest rate outlook %, end of period Actuals

Forecast

15Q1

15Q2

15Q3

15Q4

16Q1

16Q2

16Q3

16Q4

17Q1

17Q2

17Q3

17Q4

0.75 0.55 0.50 0.77 1.36 1.98

0.75 0.58 0.48 0.82 1.69 2.31

0.50 0.43 0.52 0.80 1.43 2.20

0.50 0.51 0.48 0.73 1.40 2.16

0.50 0.50 0.55 0.85 1.60 2.25

0.50 0.55 0.80 1.25 1.90 2.60

0.50 0.60 1.00 1.50 2.20 2.75

0.50 0.60 1.10 1.70 2.30 2.85

0.75 0.85 1.35 1.90 2.45 2.95

1.00 1.10 1.60 2.10 2.60 3.05

1.25 1.35 1.95 2.40 2.75 3.20

1.75 1.80 2.45 2.80 3.15 3.65

0.25 0.04 0.56 1.37 1.93 2.54

0.25 0.03 0.64 1.64 2.35 3.12

0.25 0.00 0.64 1.37 2.04 2.86

0.50 0.17 1.05 1.76 2.27 3.02

0.75 0.45 1.30 2.05 2.60 3.30

1.00 0.65 1.50 2.15 2.70 3.35

1.25 0.70 1.70 2.30 2.85 3.45

1.50 0.95 2.00 2.55 3.05 3.55

2.00 1.50 2.55 3.00 3.40 3.70

2.50 2.05 3.05 3.35 3.65 3.85

3.00 2.65 3.45 3.75 3.95 4.15

3.50 3.20 3.80 4.00 4.15 4.25

0.50 0.43 1.58

0.50 0.55 2.01

0.50 0.56 1.76

0.50 0.66 1.96

0.50 0.80 2.10

0.75 0.95 2.30

0.75 1.10 2.45

1.00 1.30 2.60

1.00 1.50 2.75

1.25 1.75 2.95

1.25 1.90 3.15

1.50 2.10 3.40

-0.20 -0.25 0.18

-0.20 -0.23 0.77

-0.20 -0.26 0.59

-0.30 -0.30 0.63

-0.30 -0.30 0.65

-0.30 -0.30 0.75

-0.30 -0.25 0.90

-0.30 -0.25 1.00

-0.30 -0.25 1.25

-0.30 -0.25 1.40

-0.30 -0.25 1.55

-0.30 -0.25 1.70

2.25 1.72 2.32

2.00 2.01 3.01

2.00 1.81 2.61

2.00 2.02 2.88

1.75 1.70 3.10

1.50 1.60 3.10

1.50 1.75 3.25

1.50 2.00 3.50

1.50 2.10 3.90

1.50 2.30 4.15

1.75 2.70 4.55

2.00 3.00 4.85

3.50 3.48 3.71

3.25 3.09 3.89

2.75 2.69 3.48

2.50 2.83 3.73

2.50 2.80 4.00

2.50 3.00 4.10

2.50 3.00 4.25

2.50 3.10 4.50

2.50 3.10 4.90

2.50 3.20 5.15

2.75 3.20 5.70

3.00 3.30 6.00

86 137 115 43 60 23

121 171 146 100 100 80

91 140 120 85 80 79

92 122 130 93 86 90

105 130 130 95 140 120

110 120 135 105 150 110

120 115 135 115 150 125

120 105 130 125 150 140

110 85 125 150 180 180

100 60 120 165 185 195

80 50 125 180 185 250

70 35 130 195 185 270

Canada Overnight Three-month Two-year Five-year 10-year 30-year

United States Fed funds** Three-month Two-year Five-year 10-year 30-year

United Kingdom Bank rate Two-year 10-year

Eurozone Deposit Rate Two-year 10-year

Australia Cash target rate Two-year 10-year

New Zealand Cash target rate Two-year swap 10-year swap

Yield curve* Canada United States United Kingdom Eurozone Australia New Zealand

* Two-year/10-year spread in basis points, **Top of 25 basis point range Source: Reuters, RBC Economics Research

Central bank policy rate %, end of period

Current United States

Fed funds

Canada

Overnight rate

United Kingdom Bank rate

Current

Last

Last

0.0-0.25 December 16, 2015

Eurozone

Deposit rate

-0.30

-0.20 December 3, 2015

0.50

0.75

July 15, 2015

Australia

Cash rate

2.00

2.25 May 5, 2015

0.50

1.00

March 5, 2009

New Zealand

Cash rate

2.50

2.75 December 10, 2015

0.25-0.50

Source: Bloomberg, Reuters, RBC Economics Research

5

Economic outlook Growth outlook % c hange, quarter-over-quarter in real GDP

15Q1

15Q2

15Q3

15Q4

16Q1

16Q2

16Q3

16Q4

17Q1

17Q2

17Q3

17Q4

2014

Canada*

-0.7

-0.3

2.3

0.0

2.2

2.4

2.4

2.5

2.7

2.8

2.6

2.5

2.5

2015F 2016F 2017F

1.2

1.8

2.6

United States*

0.6

3.9

2.0

1.4

2.5

2.9

2.8

2.7

2.4

2.7

2.6

2.8

2.4

2.4

2.5

2.7

United Kingdom

0.4

0.5

0.4

0.5

0.6

0.5

0.6

0.5

0.6

0.5

0.6

0.6

2.9

2.2

2.2

2.3

Euro Area

0.5

0.4

0.3

0.4

0.4

0.4

0.5

0.5

0.5

0.4

0.4

0.4

0.9

1.5

1.7

1.8

Australia

0.9

0.3

0.9

0.4

0.4

0.9

0.7

0.8

0.8

0.7

0.7

0.8

2.6

2.3

2.5

3.1

New Zealand

0.2

0.3

0.9

0.4

0.5

0.5

0.5

0.5

0.5

0.5

0.6

0.6

3.7

2.1

1.9

2.1

15Q2

15Q3

15Q4

16Q1

16Q2

16Q3

16Q4

17Q1

17Q2

17Q3

17Q4

2014 2015F

*annualized,

Inflation outlook % c hange, y ear-over-year

15Q1

2016F 2017F

Canada

1.1

0.9

1.2

1.4

2.1

2.0

1.9

2.1

1.9

1.8

1.8

1.8

1.9

1.1

2.0

1.8

United States

-0.1

0.0

0.1

0.5

1.7

1.5

1.7

2.3

2.4

2.4

2.3

2.1

1.6

0.1

1.8

2.3

United Kingdom

0.1

0.0

0.0

0.1

1.0

1.1

1.0

1.3

1.4

1.6

2.0

2.0

1.5

0.1

1.1

1.8

Eurozone

-0.3

0.2

0.1

0.2

0.8

0.5

0.7

1.0

1.2

1.3

1.4

1.5

0.4

0.0

0.7

1.4

Australia

1.3

1.5

1.5

2.1

2.6

2.7

2.8

2.6

2.6

2.6

2.7

2.8

2.5

1.6

2.7

2.7

New Zealand

0.3

0.4

0.4

0.6

1.1

1.0

1.2

1.5

1.6

1.6

1.6

1.7

1.2

0.4

1.2

1.6

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

Inflation tracking Inflation Watch Measure Canada United States

Current period Period ago

Bank of Canada core CPI Core PCE

1,2

United Kingdom All-items CPI Eurozone

All-items CPI

1

Australia

Trimmed mean CPI

New Zealand

All-items CPI

1

1

Year ago

Three-month trend Six-month trend

Nov

0.1

2.0

1.5

2.3

Nov

0.1

1.3

1.3

1.5

Nov

-0.1

0.1

0.3

0.8

Dec

-0.3

0.2

-0.5

0.4

Q3

0.3

2.1

N/A

N/A

Q3

0.3

0.4

N/A

N/A

1 Seasonally adjusted measurement. 2 Personal consumption expenditures less food and energy price indices.

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

6

Currency outlook Level, end of period

Actuals

Forecast

15Q1

15Q2

15Q3

15Q4

16Q1

16Q2

16Q3

16Q4

17Q1

17Q2

17Q3

17Q4

Canadian dollar

1.27

1.25

1.33

1.38

1.45

1.40

1.36

1.33

1.31

1.29

1.27

1.25

Euro

1.07

1.11

1.12

1.09

1.03

1.00

1.00

1.02

1.03

1.04

1.05

1.06

U.K. pound sterling

1.48

1.57

1.51

1.47

1.51

1.47

1.45

1.48

1.51

1.55

1.59

1.63

New Zealand dollar

0.75

0.68

0.64

0.68

0.64

0.63

0.63

0.63

0.64

0.64

0.65

0.66

Japanese yen

120.1

122.5

119.9

120.2

128.0

132.0

130.0

128.0

126.0

124.0

122.0

120.0

Australian dollar

0.76

0.77

0.70

0.73

0.67

0.65

0.65

0.65

0.66

0.66

0.67

0.68

Canadian dollar cross-rates 15Q1

15Q2

15Q3

15Q4

16Q1

16Q2

16Q3

16Q4

17Q1

17Q2

17Q3

17Q4

EUR/CAD

1.36

1.39

1.49

1.50

1.49

1.40

1.36

1.36

1.35

1.34

1.33

1.33

GBP/CAD

1.88

1.96

2.01

2.04

2.20

2.06

1.97

1.97

1.98

2.00

2.02

2.04

NZD/CAD

0.95

0.85

0.85

0.95

0.93

0.88

0.86

0.84

0.84

0.83

0.83

0.83

CAD/JPY

94.7

98.0

90.0

86.9

88.3

94.3

95.6

96.2

96.2

96.1

96.1

96.0

AUD/CAD

0.97

0.96

0.93

1.01

0.97

0.91

0.88

0.86

0.86

0.85

0.85

0.85

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.

Source: Bloomberg, RBC Economics Research

RBC Economics outlook compared to the market 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.

Euro

Canadian dollar 1.50

1.60 1.50

1.40

1.40 1.30

1.30 1.20

1.20

1.10 1.10

1.00 1.00

0.90 0.80 Jan-15

Jul-15

Jan-16

Jul-16

0.90 Jan-15

Jul-15

Jan-16

Jul-16

U.K. pound

Japanese yen 2.00

136

126

1.80

116 1.60

106

1.40

96

86 Jan-15

Jul-15

Jan-16

Jul-16

1.20 Jan-15

Jul-15

Jan-16

Jul-16

7

Central bank watch Bank of Canada Canadian GDP was flat in October 2015, defying expectations for some retracement of September’s 0.5% decline. The weak start to the quarter pushes our Q4/15 growth forecast down to 0%. The BoC will address a wider than expected output gap and weaker oil prices in its January 20 MPR and policy statement, but Governor Poloz did not seem in any rush to cut rates, in his recent speech.

Canadian overnight rate

Canadian real GDP growth

%

Quarter-over-quarter annualized % change

7

8

Forecast

6

6

4 5

2 4

-2

3

-4 2

-6 -8

1

-10 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Statistics Canada, RBC Economics Research

Federal Reserve

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

U.S. target rate Forecast 6

4

5

2 4

-2

3

-4 2

-6 1

-8 -10 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Bureau of Economics Analysis, RBC Economics Research

0 2002

Forecasted values:

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

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

ECB Deposit rate

Eurozone GDP % change, quarter-over-quarter

%

1.5

7

1.0

6

Forecast

0.5

5

0.0 4

-0.5 -1.0

3

-1.5

2

-2.0 1

-2.5

0

-3.0 -3.5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Eurostat, RBC Economics Research

Forecasted values:

-1 2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Source: ECB, RBC Economics Research

U.K. policy rate

U.K. real GDP growth

%

1.5

7

1.0

6

0.5

5

Forecast

0.0

4

-0.5

3 -1.0

2

-1.5

1

-2.0 -2.5 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Central Statistical Office, RBC Economics Research

Australia and New Zealand

8

2006

%

% change, quarter-over-quarter

The RBA ended 2015 with an optimistic tone, thereby reflecting firmer domestic data recently, but we expect subdued activity in 2016 will prompt additional easing. The RBNZ cut rates by another 25bp in December 2015 and noted that monetary policy is now sufficiently stimulative to achieve its (recently lowered) inflation projection. We expect the cash rate will be held steady in 2016.

2005

7

6

Bank of England Survey indicators support our forecast for a 0.5% increase in Q4/15 GDP, although there is a risk that recent flooding weighs on the quarterly reading. While our forecast assumes inflation will remain almost a percentage point below the BoE’s 2% target throughout much of 2016, limited slack in the economy calls for tighter monetary policy this year.

2004

8

European Central Bank Survey indicators picked up to their strongest levels in four years in Q4/15. The consistently positive signal is expected to be confirmed with a 0.4% gain in Q4 GDP. While we do not expect any policy moves from the ECB after December’s easing, another disappointing inflation reading could prompt a more dovish tone from the central bank.

2003

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

U.S. real GDP growth Quarter-over-quarter annualized % change

We expect GDP growth softened somewhat toward the end of 2015 with a 1.4% gain expected in Q4/15; however, domestic spending growth is likely to be closer to trend. Our forecast assumes the Fed will hold rates steady in January 2016 before following up December 2015’s rate increase with another 25 basis point hike in March.

0 2002

Forecasted values:

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Forecasted values: Source: Bank of England, RBC Economics Research

Australia and New Zealand GDP growth 2.5

Australia and New Zealand inflation

% change, quarter-over-quarter

7

% change, year-over-year

Forecast 2.0

Forecast 6

1.5

Australia New Zealand

5

1.0 4

0.5 3

0.0 2

-0.5

Australia New Zealand

-1.0 -1.5

1 0

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research

Markets see lower oil prices and soft growth as setting the stage for a BoC rate cut by year end.

Market pricing is now implying a 72% probability of a BoC rate cut by the end of 2016.

Expected Bank of Canada Overnight Rate for Dec. 7, 2016 Meeting

Given renewed weakness in oil prices, WTI is now forecasted to average just above US$50/barrel in 2016.

West Texas Intermediate (WTI) $US/bbl

Implied Probability % 45

140 Forecast

40

120

35

100

30 25

80

20

60 15

40

10 5

Annual Levels

20 -0.25

0

0.25

2014 $93

WTI

2015 $49

2016f $52

2017f $62

0.75

0.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Bloomberg as of Jan. 7, 2016, RBC Economics Research

Source: Energy Information Administration/Wall Street Journal, RBC Economics Research

Low oil prices and monetary policy divergence pushed the Canadian dollar even lower in December and early-January. We expect CAD will weaken to US$0.69 at the end of Q1 before recovering slowly thereafter.

Canadian GDP growth was unexpectedly flat in October following a 0.5% decline in September. Even with a rebound in the final two months of 2015, Q4 growth is expected to be flat.

Canadian dollar forecast

Canada: Real GDP

US$/C$ 1.1

% change, month-over-month 0.8

Forecast 0.6

1.0

Parity

0.4

0.9

0.2 0.0

0.8

-0.2

End of period

0.7 US$/C$

2014 2015 2016f 2017f 0.86 0.72 0.75 0.80

-0.4 -0.6

0.6 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

Source: Bank of Canada, RBC Economics Research Forecasts

2011

2012

2013

2014

2015

Source: Statistics Canada, RBC Economics Research

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 authorization 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 information 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.

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