Rates Scenario. Forecast Summary (averages) Since the last issue of Rates Scenario (on December 15 th ):

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1 An outlook on key interest and foreign exchange rates December 22, 2017 Michael Gregory, CFA, Deputy Chief Economist Jennifer Lee, Senior Economist Benjamin Reitzes, Canadian Rates & Macro Strategist Carl Campus, Economist Forecast Summary (averages) BoC overnight yr Canadas Fed funds yr Treasuries C$ per US$ US$/ US$/ /US$ * actual Dec figures are month-to-date as of Dec. 21, 2017 Since the last issue of Rates Scenario (on December 15 th ): The Tax Cuts and Jobs Act of 2017 contained more front-loaded tax cuts than expected, leading us to raise our forecast for average U.S. economic growth from 2.4% in 2018 to 2.6%, pull forward the timing of Fed rate hikes (from our previous June-September-December sequence), and raise the net risk of more moves. We now look for March-June-December hikes, identical to 2017 s pattern, with significant net risk of a September move. The more aggressive Fed posture reflects two factors. First, upside inflation risks elicited by an economy growing at an even greater above-potential pace with no output gap and essentially at full employment, likely ameliorate some of the Fed s inflation uncertainties. Interestingly, in the latest Summary of Economic Projections, the FOMC s median forecast for real GDP growth in 2018 was revised up by a hefty 4/10s to 2.5% Q4/Q4, factoring in fiscal stimulus along with stronger momentum from this year. The out-years were also upgraded. However, the inflation profile remained unchanged. It appears the Fed is betting that current secular disinflationary trends (owing to, for example, technology-enabled disruption and globalization) can continue countering cyclical inflation pressures. And, perhaps, that tax cuts will spur more capacity growth. We remain sceptical, judging that tax-cut-stoked demand will probably dominate tax-cut-incented supply and drive inflation moderately higher. Second, the unintended consequences of balance sheet shrinkage seem to be less of a Fed concern. Indeed, the FOMC removed all references to balance sheet normalization in the December 13 th statement. Again, we remain sceptical about a benign normalization process, particularly once assets start shrinking as much as $50 bln per month by October. So, we watch the inflation tug-of-war between competing inflation/fed prospects. Lined up on one side (the unfavourables ) is continued above-potential growth with no output gap and the added demand pull from tax cuts. On the other side (the favourables ) is capital spending incented by capacity constraints and tax cuts along with secular disinflationary trends. We expect the unfavourables to have the upper hand but stay well shy of victory, for the time being. However, should the unfavourables appear headed for victory, it will take only a couple of extra Fed rate hikes to completely offset the positive economic impact of tax cuts. A publication of BMO Capital Markets Economic Research Douglas Porter, CFA, Chief Economist economics.bmocapitalmarkets.com

2 Page 2 of 5 December 22, 2017 We continue to shift the risks around our Bank of Canada call. The Bank s December 6 th policy statement read more dovish than expected, with labour market slack still emphasized despite a 5.9% jobless rate (matching a decade-low) and accelerating wages. However, in the first post-announcement speech (December 14 th ), Governor Poloz said we are growing increasingly confident that the economy will need less monetary stimulus over time, countering the dovish read from the week before. Poloz reiterated that we will continue to be cautious in our upcoming policy decisions, guided by incoming data in assessing the economy s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation. Of course, caution is also dictated by new (more onerous) mortgage lending rules that take effect January 1 st, and the fate of NAFTA talks. With respect to the latter, we now judge the odds of an unfavourable outcome, either an abrogated NAFTA or a zombie NAFTA (with talks failing but abrogation held up, say, by legal actions), are better than even. Reflecting the increased economic risk, we now judge there are net downside risks to our 2018 forecast (rate hikes in March, July and October). The ECB is ending 2017 on a much more optimistic note. The central bank raised its growth forecast sharply for the next couple of years; but, given that underlying inflation has yet to show convincing signs of an upturn, left inflation forecasts little changed. Although inflation is expected to average 1.7% in 2020, it may not be close enough to target for the ECB to raise rates just yet. But something has to give, particularly after the Governing Council raised the GDP forecast 0.5 ppts to 2.3% next year and 0.2 ppts to 1.9% in With these growth expectations, and with monthly bond purchases slated to be slashed in half starting in January, it is becoming more likely that President Draghi will set the stage, possibly by September, for the QE program to finish by the end of The BoE maintains its cautious stance as 2017 comes to a close. Yes, it took back the post-referendum emergency rate cut, the economic data have stabilized and, importantly, inflation is at a 5½-year high. And yes, the Brexit negotiations are finally moving on to Phase 2. However, the central bank tweaked the language a bit in December, from specifying that their assessment was based on two more 25 bp rate hikes over the forecast horizon, to further modest increases would be warranted over the next few years. Our Stephen Gallo, Head of European FX Strategy, believes the more vague statement buys the Bank some flexibility; and, we fully agree. There will be some rough periods over the next year but, as we progress through 2018, more clarity on the future trade relationship and the 2-year transition period will support another bump up in the Bank Rate. The BoJ continues to face inflation that is far from the 2% target; thus, we do not expect the overnight rate to change in But, as growth has steadily improved throughout most of 2017, we believe the BoJ will adjust its policy of keeping 10-year JGB yields around 0%; and perhaps lift the target level 1/10 th by year-end. Banco de Mexico tightened five times in 2017 as inflation hit 16-year highs, but that runs the risk of destabilizing an economy that could be hit hard if NAFTA is terminated. Much like the BoE, it depends on how much inflation, stemming from a weaker MXN, the central bank can tolerate in this highly uncertain environment. The RBA stuck to its cautious script in December, holding rates steady at a record-low 1.5% for the 15 th consecutive meeting. While employment growth has picked up to the fastest pace in nearly a decade, slow wage growth, elevated household debt and below-target inflation are keeping the RBA firmly planted on the sidelines for the time being. And, in a bid to cool credit demand, the PBoC raised rates at the end of With economic growth expected to cool but remain solid at around 6.8% next year, look for further rate hikes although Beijing appears to have tempered its focus to stem borrowing.

3 Page 3 of 5 December 22, 2017 Foreign Exchange Forecasts Local Currency per U.S. Dollar (averages) Canadian Dollar C$ per US$ US$ per C$ Trade-weighted U.S. Dollar Trade-weighted¹ European Currencies Euro² Danish Krone Norwegian Krone Swedish Krone Swiss Franc U.K. Pound² Asian Currencies Chinese Yuan Japanese Yen Korean Won 1,087 1,090 1,090 1,085 1,085 1,085 1,080 1,085 1,090 1,095 1,100 Indian Rupee Singapore Dollar Malaysian Ringgit Thai Baht Philippine Peso Taiwan Dollar Indonesian Rupiah 13,554 13,525 13,495 13,470 13,415 13,335 13,260 13,235 13,245 13,255 13,265 Other Currencies Australian Dollar² New Zealand Dollar² Mexican Peso Brazilian Real Russian Ruble South African Rand Cross Rates Versus Canadian Dollar Euro (C$/ ) U.K. Pound (C$/ ) Japanese Yen ( /C$) Australian Dollar (C$/A$) Versus Euro U.K. Pound ( / ) Japanese Yen ( / ) * actual Dec figures are month-to-date as of Dec. 21, 2017 ¹ Federal Reserve Broad Index ² (US$ per local currency)

4 Page 4 of 5 December 22, 2017 Interest Rate Forecasts Percent (averages) Cdn. Yield Curve Overnight month month year year year year year year year m BA m BA m BA m BA Prime Rate U.S. Yield Curve Fed funds month month year year year year year year year m LIBOR m LIBOR m LIBOR m LIBOR Prime Rate Other G7 Yields ECB Refi yr Bund BoE Repo yr Gilt BoJ O/N yr JGB * actual Dec figures are month-to-date as of Dec. 21, 2017

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Rates Scenario. Forecast Summary (averages) Since the last issue of Rates Scenario:

Rates Scenario. Forecast Summary (averages) Since the last issue of Rates Scenario: An outlook on key interest and foreign exchange rates March 2, 2018 Michael Gregory, CFA, Deputy Chief Economist michael.gregory@bmo.com 416-359-4747 Jennifer Lee, Senior Economist jennifer.lee@bmo.com