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FX Daily39 .pdf

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Deutsche Bank
Markets Research

Foreign Exchange
FX Spot

13 November 2013

FX Daily
Still bearish GBP vs USD, neutral on
There are two large cross-currents impacting sterling at the moment. Here's our
assessment of each and ultimate implications for GBP.
On the positive side, the economy is outperforming even the highest of expectations.
There's been little payback to the unusually warm summer, the business surveys are
holding up at levels above consensus GDP forecasts for this quarter and house prices
have clearly turned a corner even if dominated by London. Despite yesterday's downside
surprise in inflation, the risk is that wage growth soon starts picking up (chart 1). As a
result, UK yields have been stickier than other developed markets, with the market now
pricing the first BoE hikes by mid-2015, well ahead of the ECB and even the Fed.
On the other hand, developments have been very negative on the flow side. The last few
trade numbers have been disappointing, with the Q2 current account deficit at more
than 4% GDP, and the September trade numbers posting a record annualized deficit with
the EU of more than 70bn EUR. This deterioration will not bring the end of the world, but
it is tough to build a fundamentally bullish case for sterling under such negative flow
dynamics - the more the domestic demand-led recovery continues, the greater the
deterioration in the trade accounts as British consumers import more.
Combining the above leaves us with an unchanged sterling view relative to our
September FX Blueprint: bearish GBP/USD and neutral EUR/GBP. Near-term, we see the
risks as skewed towards disappointment for those looking for a hawkish BoE inflation
report this morning: the market is already priced for hikes by mid-15, and we see it
unlikely that the committee brings forward tightening earlier than that today. Combined
with USD strength and stale sterling longs, we see the potential for cable to reverse to
the mid-1.50s by the end of the year. On EUR/GBP, the flow dynamics are just too
negative to turn outright bearish, despite the monetary policy divergence: with close to
70bn EUR of negative sterling trade flow to fight each year, we want a few more
months' evidence that current UK strength will force the BoE's hand in 2014 before
changing view.

Strength of Domestic Recovery Undeniable

But Leading to Much Weaker Flow Dynamics for GBP



UK Trade Balance with EU, bn GBP

00 01 02 03 04 05 06 07 08 09 10 11 12
Source: Deutsche Bank, Bloomberg Finance LP

Deutsche Bank AG/London

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