From: Daniel Sabba ctl

From: Daniel Sabba ctl To: "'Jeffrey E."' leevacation@gmail.com> CC: Paul Morris Stepanian , Stewart Oldfield WM>, Vahe , "Arlene Dwyer" , "'Richard Kahn"' Subject: Changing DB's view on GBP, turning very bearish [C] Date: Thu, 05 Nov 2015 18:25:50 +0000 lane -Images: image001.jpg; image002.jpg; image003.gif; image004.gif Classification: Confidential Jeffrey - please see below. From: George Saravelos Sent: Thursday, November 05, 2015 11:27 AM Cc: Oliver Harvey Subject: Changing our view on GBP, turning very bearish From Oliver Harvey: Today's November BoE inflation report marked a fundamental departure from recent Bank of England communication on the prospects of policy tightening. First, the Bank explicitly validated dovish market repricing after the September period of risk aversion. The 2-year-ahead CPI forecast was essentially unchanged from August at just above 2%, but was based on a market yield curve implying the first rate hike in Q1 2017. Second, the risk to this forecast was seen as 'to the downside.' Third, the Bank talked up the impact of sterling strength on the CPI over the whole course of the forecast horizon, based on new work by bank staff. In this sense, the BoE has clearly followed the lead of the ECB and not the Fed by prioritizing a weak external environment over domestic developments, and expressing intolerance of further FX appreciation. This changes our long-standing bullish GBP call held since September 2014. We take profit on our short EUR/GBP and long GBP/USD trade from the September Blueprint at a gain of 1.35%, and now see three reasons to turn outright bearish the pound: I) Short-end rates now suggest GBP downside. Reacting to today's report, short-end rates have shifted hikes back into 2017. GBP/USD has closely tracked the relative timing of UK vs. US rate hikes and this mechanically implies the cross below 1.50. As well as the short term reaction, though, rate support may be undermined more broadly. 2) The window for policy exit may now close. Absent a remarkable volte-face, the MPC has now relinquished its optionality for a hike in HI next year. The problem is that it may be too late after that for exit. Fiscal tightening is set to pick-up sharply in 2016, with the UK undergoing the largest fiscal consolidation of any GI0 economy, at 1.5% of GDP. Growth has already slowed sharply from over 3% in late 2014 back towards trend. Autumn next year is also the most likely time for an in-out EU referendum. As we have recently written, the outcome appears to be becoming increasingly close, with an 'out' vote carrying huge political and economic consequences. 3) Absent rate support, sterling much more vulnerable to twin deficits and expensive valuation. A robust recovery and high interest rates relative to European peers has helped to finance a very large deterioration in the UK's current account deficit since 2011. As we have previously argued, much of this is structural; a result of falling profitability in the UK's highly concentrated foreign direct investments dragging on the income balance. If rate support were to fade, slowing foreign capital inflows could see a sharp correction in sterling. Given the prospect of another four years of fiscal tightening, a weaker currency should also be beneficial to the UK's growth mix, which EFTA00674379 remains geared towards consumption. This makes valuations very unappealing. As my colleague George Saravelos has argued, the pound is now the most expensive currency in the world measured on an average of REER, BEER and FEER valuation metrics. In sum, with a near-term hiking cycle off the table, the rationale for being long sterling has disappeared. Further analysis will need to be undertaken for the future outlook. In the meantime we recommend turning short GBP/USD, which should also benefit from our bearish EUR/USD call. Our GBP/USD forecast for end-2016 and end-20I7 is 1.27 and 1.15 respectively. Figure 1 Monetary policy repricing suggests GBP/USD I Figure 2. Fiscal tightening will pick up sharply next year downside Nkaytber of mach, to UK- US rote It 14 G8P)1./$0. 9 4 -1 -6 -11 -16 A,14 Art•14 .44-14 013.14 J011.15 ADNIS ASIS 1.73 lel 143 53 1.48 1.43 in the UK S OM forecast of cydstally adjusted isoartigteening, %GDP r:sariewot 2 .1.1ac+4.Apt •Dockonv•korwa IS 06 0 .06 .1 2011.15 2015.16 201647 2017.15 201619 2019.20 202021 Sinew Data &at ele CetbergIOWee• LP SOS Oaf* —OW I Figure 3. UK's very large current account deficit, even relative to trend, to become a problem arrest 84.034t4 Warta %GDP ......... . Deo% 4410 63 Awl) C114-78 .44495 ADVS4 13•4•01 A/409 'Figure 4: Sterling is world's most expensive currency Global Currency Valuations Wales most expensive vw 440 cOP 0 .3 • MON 116 eXperliivt SOO ct s erioest CAD a IWO TRY • Laineaft• swan*. ...vs+ eta swag ono OnOrt~••••••••••1 wen dieela MTh '0 zee t. aceneynrsorototivey p /11106111 Sas Ones Ant *Kamm Ian LP se/etwOossaareesse George Saravelos FX Research Deutsche Bank AG, Filial° London Win .heater 1-Innse 1 Great Winchester reet, EC2N 2DB London, United Kingdom Tel EFTA00674380 Mobile Email Pas?ioltiv- Perfon)t This communication may contain confidential and/or privileged information. If you are not the intended recipient (or have received this communication in error) please notify the sender immediately and destroy this communication. Any unauthorized copying, disclosure or distribution of the material in this communication is strictly forbidden. Deutsche Bank does not render legal or tax advice, and the information contained in this communication should not be regarded as such. EFTA00674381