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Deutsche.02.12.14 .pdf


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Deutsche Bank
Markets Research
Global

Foreign Exchange
FX Spot

Date
12 February 2014

FX Daily
Don't fear Carney creep, follow the
flow
Arguments over spare capacity and productivity may seem arcane, but they
are important for currencies. Relative output gaps have done a good job of
explaining sterling performance against the majors over the last two decades.
Today, the Bank of England will reassess its views of spare capacity in the UK
economy. Even if the central bank abandons the dramatically falling
unemployment rate as its real activity indicator for forward guidance, as
expected, we think those hoping for a dovish outcome may be disappointed.
First, rates market pricing has retraced to close to November Inflation Report
levels. Then, the first hike was being priced ‘in line’ with the Bank’s
assessment of the probability of the unemployment rate falling below 7%
(around mid-2015). This suggests the market already anticipates a replacement
for the unemployment rate as a tool to keep rates expectations on hold until
the middle of next year. Second, pricing remains dovish. Our fixed income
strategist has noted that both the pace of hikes and terminal rates already
imply a very cautious Bank of England relative to history.*
Looking ahead, however, we don’t see economic data as the key driver of
sterling strength, as last year. To be sure, indicators remain exceptionally
strong, but most have stabilized or declined in recent weeks, and the pound
has correlated more with the change than the level of data in the past. Instead,
we would argue that it will be capital flows rather than growth that help GBP.
One source is FDI. While M&A inflows have so far failed to materialze, the
cheapest equity valuations in G10 and a strong cycle should see this change.
We therefore like to play sterling against currencies with weak flow dynamics
(such as CAD), but would be more cautious against the EUR and USD, where
the current account and FDI respectively mean flows are also supportive.

Relative output gaps explain pound performance
5
4

110

UK-Average G3 Output gaps, OBR
UK-Average G3 Output gaps, IMF

110

GBP Nominal TWI

105

3
2
1

-1

100

95

95

90

90
85

80
75

-2

70

-3
Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15

65

Source: Deutsche Bank, Bloomberg Finance LP, IMF, OBR

GBP TWI
Net Financial Flows (bns, 4q sum, rhs)

105

100

85
0

Financial flows already supportive of higher GBP
250
200
150
100
50

80
75
70
Jan-90 Feb-93 Mar-96 Apr-99 May-02 Jun-05 Jul-08 Aug-11

0
-50

Source: Deutsche Bank

*See UK Fixed Income Weekly, Soniya Sadeesh, Waiting For Guidance, 7th February 2014

________________________________________________________________________________________________________________
Deutsche Bank Securities Inc.


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