Deutsche Bank makes the bearish case for sterling

Deutsche Bank analyst George Saravelos says it's not yet time to turn bullish sterling:

UK data has been unambiguously strong recently, but we remain bearish GBP.

First, similar to the yen, we don’t think outright growth matters for a currency, but how it translates into flow. For the UK, we believe the likelihood is stronger data translate into weaker flow. We’ve already written about UK portfolio outflows, which tend to rise when risk appetite strengthens. More importantly, an improving UK cycle risks a further deterioration in the trade deficit. The growth-deficit relationship has been tight over the last decade. It broke down in 2011, when the deficit widened back sharply despite depressed domestic demand. High FX import pass-through and a reversal in commodity prices were mostly to blame. But the post-2011 widening means that the cyclicallyadjusted deficit is even worse than current levels. With energy exports a drag (unlike the US) and the nascent recovery attributable to an improving housing and domestic credit cycle rather than exports, it looks like better growth will translate into a weaker, not stronger current account.

Second, we don’t think better growth numbers will translate into tighter monetary policy either. It is too early to justify a hawkish turn, with the output gap large and both household and government leverage higher than the US. It took twelve months for a third of the MPC to start voting for hikes the last time the PMIs were at this level. In contrast, we expect incoming Governor Carney will introduce verbal guidance. We will get more clarity in the August inflation report rather than today’s MPC meeting, but guidance would be a “cheaper” option of counter-acting the recent pick-up in rates volatility while also allowing the BoE to draw a line between itself and the Fed.

In sum, we think it’s too early to turn bullish GBP both from a flow and a monetary policy perspective. We remain bearish GBP/USD targeting the low 1.40s and see EUR/GBP holding the mid-80s.