EFTA01451171.pdf

9 January 2014 FX Blueprint: Thin end of the wedge Theme 1t3: - Home Counties trump Mounties ▪ Inflation risks and potential FDI inflows should lInflation Could Be Here Sooner Than Market Expects keep sterling supported this year, but a widening current account deficit and stronger USD will 58.0 Emplyt PMI, 9m lead 6 constrain gains versus the euro and dollar. We are -GBP AWE rag pay, priv moderately bearish EUR/GBP and GBP/USD. 56.01 forecasting 80p and 1.54 by end-year respectively. 54.0 • As an outright trade we prefer buying GBP versus 52.0 1 CAD, on which we are more bearish. It remains 50.0 1 vulnerable to an equally-large current account deficit, CE-flow unwinds and unwinding internal 48.0 imbalances. 46.0 -I The UK domestic demand cycle has kicked in quicker, 44.0 stronger and more sustainably than anticipated. We 42.0 see inflation and FDI inflows as being the major source of upside risk for GBP next year. 40.0 4- •0 Jan-01 Mar-03 May-05 Jul-07 Sap-09 Nov-11 Son Orsesi Atins Mont IMF Inflation, not deflation to be theme in 2014 Last year was all about UK growth expectations. This year, the risk is attention turns to prices. First, even ,FDI Upside Risk To GBP Next Year though recent inflation prints have surprised to the so sessIget la UK %de and 100050/11200 Iona Ingewrient inns GBP downside, pipeline pressure is building. Productivity is not recovering as quickly as the BoE is expecting, 50 leading to a much faster than expected drop in the unemployment rate. In turn, wage inflation could 40 accelerate sharply in 2014 (chart 1). Second, the starting point of inflation is much higher in the UK than 30 the rest of G10. Any turn in the trend will focus minds much more quickly than elsewhere. With the first BoE rate hike still only priced for mid-2015 (a bit earlier than 20 the Fed), there is plenty of potential for near-term yield support as price pressure builds. 10 Outside of monetary policy, FIN is another source of 0 1201 I2040 I I support. Excluding the Verizone-Vodafone deal, UK 2011 2012 2013 inbound M&A has been muted by pre-crisis standards. Sete • DpaLlp &Pit SO0nberg &.,C* LLP But UK deal-flow is pro-cyclical, tracking the broad trends in equities and global M&A transactions well. IEURIGBP Holding Up Better on Back of Flovv Our equity analysts are positive on both this year. Add to that the UK government's increasing dedication to i EUR/GBP (6m lag. Ihs) - 130 attracting foreign investment - particularly into the 1 RICS House Price Balance (rhs, inverted) publicly-owned banks - (chart 2) and FDI stands out as 60 a potential additional source of support for GBP in 2014. 0.9 Current Account Deficit Will Constrain Gains vs EUB :33 0.8 On the flipside, the UK recovery is happening for the "wrong" reasons. Domestic demand, not exports are -20 driving the cycle. The current account deficit is 0.7 deteriorating and stands in contrast to the US and Euro-area. This goes a long way to explain the lag in 0.6 1 EUR/GBP versus cyclical indicators (chart 3). This is reflected in our conservative EUR/GBP forecasts: we see a slow grind lower to 0.80 by the end of the year, 0.5 12( with GBP/USD revisiting the low 1.50s on the back of a 94 96 98 00 02 04 06 08 10 12 strong USD. San Dash* Sant ebonies Ares*UP J Deutsche Bank AG/London Page 7 CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0107445 CONFIDENTIAL SDNY_GM_00253629 EFTA01451171