Australian and New Zealand Dollars Savage Pound Sterling as Superior Interest Rate Yields are Sought

• British Pound to New Zealand Dollar exchange rate: 1.7218
• Pound to Australian Dollar exchange rate: 1.6354

The UK currency was hammered by its major trading partners after the Bank of England communicated to markets in no uncertain terms that an interest rate rise remains highly unlikely over coming months.

However, it was against the high-yielding commodity Dollars were the lion’s share of punishment was delivered.

"While the Bank of England spent most of the afternoon revising things higher, one figure was taken lower; by the start of 2018 the central bank now expects inflation to be at 2.7%, not 2.8%. Combine this with comments from Carney suggesting he could also see scenarios where rates move in ‘either direction’ and things were more dovish than the Pound would have liked," says Connor Campbell at Spreadex in London.

The upgraded forecasts were attributed to the benefits that a weaker currency brings and an adjustment of their dire views of the economic damage that Brexit would have on the economy.

However, what really got the Pound falling was a downgrade to inflation with the Bank now expecting inflation to peak at 2.8%.

The Bank's mandate is to move interest rates in response to inflation - so when inflation is rising we would typically expect interest rate rises to be the response.

This is positive for Sterling.

However, by keeping inflation forecasts static and warning that the labour market is unlikely to generate upward pressure on prices for some time, markets get the hint that the Bank will not move on rates. 

Biggest Losses against NZD and AUD

All three of the commodity currencies traded higher against their peers with the Australian Dollar leading the gains.

The Aussie rose by nearly 1% on the back of better than expected trade balance numbers.  The country reported a trade surplus of $3511m, which was much higher than the $2000m forecast. 

The upside surprise was fueled by stronger exports and imports.

The Pound was therefore already notably lower against AUD and NZD going into the Inflation Report.

That New Zealand and Australia offer some of the highest central bank interest rates in the developed world also tells us something - investors are seeking out yield.

The UK is not going to offer higher returns on money market investments over coming months as the basic rate set by the Bank of England is likely to remain capped at 0.25%.

By pushing the GBP/NZD exchange rate higher markets are betting that they will have better returns on their capital in New Zealand.

Indeed, with the Kiwi economy remaining red-hot there is increasing talk of an interest rate rise at the RBNZ in 2017.

While recent wage growth data disappointed markets it is forecast to grow through 2017. This combined with news inflation is ticking higher once more suggests the Reserve Bank of New Zealand (RBNZ) will raise rates.

The GBP/NZD has slumped back down to 1.7130 and could well be on target to test the long-standing support at ~1.69 again.

Meanwhile, we would expect any chances of a move above ~1.74 as being an incredibly hard call considering just how solid resistance at this point has been of late.

Looking at the GBP/AUD, Australia is less likely to see an interest rate rise over coming months than New Zealand is, but the country still commands a profitable cash rate at 1.50%.

We see the GBP/AUD potentially heading back down to mid-January lows towards 1.60 on the back of Thursday’s massive slip lower.