Pound-to-New Zealand Dollar Rate On the Edge as Brexit Lawfare Dominates Sterling...Again

-GBP/NZD nears precipice amid fresh lawfare over Brexit treaty.
-As Brexit endgame nears and trade deal still eludes negotiators.
-GBP/NZD tests major support levels with ‘no deal’ fears on rise.
-ANZ eyes 1.85 short-term, as ‘no deal’ risks fall as far as 1.74.

Image courtesy of Aurelien Guichard, accessed Flickr, reproduced under Creative Commons licensing conditions. File Image © Adobe Stock

• GBP/NZD spot rate at time of writing: 1.9190
• Bank transfer rate (indicative guide): 1.8520-1.8655
• FX specialist providers (indicative guide): 1.8904-1.9019
• More information on FX specialist rates here

The Pound-to-New Zealand Dollar rate has crumbled and been left testing major technical support levels after the gloves came off in the Brexit negotiations, although it could be pushed over the edge of a precipice if an ongoing row between London and Brussels leads to an acrimonious break with the EU.

Pound Sterling has fallen to its 200-week moving-average and the 50% Fibonacci retracement of its post-referendum recovery from 1.6370 in October 2016, to 2.18 in March 2020, amid market concern over the new Internal Market Bill that in the government's own words, will "breach international law," but which is intended as “a legal safety net designed to protect our country against extreme or irrational interpretations” of the EU Withdrawal Agreement.

This leaves the Pound-to-New Zealand Dollar rate teetering on the edge of a precipice and puts it at risk of declines that could reach -10% if relations with the EU turn more awry in the months ahead, although in the interim the next immediate destination for the Pound is the July 2019 lows that were seen the last time Brexit concerns left a mark on the British currency.

“The backdrop to the UK’s trade talks with the EU is deteriorating. GBP weakness is a direct result of growing no deal expectations. Our target of 0.52 has been reached but given the current debacle in UK trade policy, 0.54 is feasible,” says David Croy, a strategist at ANZ, warning of a GBP/NZD fall to 1.8518. “NZD underperformed against most G10 during the overnight session, with GBP the key exception breaking through 0.52.”

The bill establishes a mechanism and precedent through which terms of the new EU treaty and its Northern Irish protocol can be overwritten, ‘clarified’ or disapplied. It's enraged Brussels as well as drawn condemnation from certain political figures and parts of the commentariat in Britain.

Brussel's interpretation of of the Withdrawal Agreement’s terms alarmed London, and has set the stage for a domestic and international political clash that threatens to derail the trade talks with the EU. Trade talks need to wrap up in sufficient time for any agreement to be ratified before December 31.

 Above: Pound-to-New Zealand Dollar rate shown at daily intervals with 200-day moving-average and Fibonacci retracements of March-to-July decline. Shows August rally failing at 61.8% retracement level.

The EU has demanded the government drop or amend the bill and is threatening legal action and a trade war, which might be little more than a new name for a ‘no deal’ Brexit, but the bottom line is that Sterling will immediately have to pick up part of the tab if relations with Brussels worsen.

“Late afternoon the EU gave us a one month deadline to amend the Bill. Safe passage of the IMS through the Commons is all but assured with the majority Bo-Jo commands but discontent within the Lords will make it an altogether trickier proposition. There is still a train of thought that this is a high stakes negotiating tactic but my sense all along is the current administration would be comfortable walking away from FTA negotiations,” says Michael Waugh-Bacchus from the sales & trading desk at Deutsche Bank, referring to Thursday afternoon in which heavy losses washed over Sterling exchange rates including the Pound-to-New Zealand Dollar rate. “Stay short, good luck.”

A breakdown in the relationship with the EU and acrimonious exit from the transition period, which has preserved all but a few features of membership until December 31, would not only require the two sides to trade under the most favoured nation tariff of the World Trade Organization.

It could also see Brussels proactively attempting to damage the UK economy through law and regulation changes designed to coerce European and other international financial firms into downscaling their presence in London.

EU attempts to undermine the City of London have so-far fallen flat but this doesn’t mean it won’t eventually succeed to some extent, and nor has it prevented Sterling from fretting about the trajectory of relations.

“We’re now in a no man’s land of levels with very few GBP barriers to judge where GBP can find support here. It’s likely this move lower in GBP continues until we find a concrete reason to buy GBP back (such as parliament blocking the internal market bill, government U-turns or EU compromise,” says Jordan Rochester, a strategist at Nomura. “For now the UK and EU are at a stalemate with time working against them, no deal is a real possibility and 1.20 in GBP/USD or 0.98 in EUR/GBP are still very possible.”

 Above: Pound-to-New Zealand Dollar rate shown at weekly intervals with 200-week moving-average (black line) and Fibonacci retracements of post-referendum recovery. Sterling is testing the 50% retracement and would hit the 61.8% retracement if ANZ's 1.85 forecast is realised.

“Securing a FTA with the EU has now become harder unless the UK concedes key demands by the EU on state aid and fisheries. Or if by some surprise either side offers a new olive branch we’ve not yet seen considered. It’s becoming very difficult to see the light at the end of the tunnel. Unless this was always just a negotiation tactic and the UK has a few moves left to get things back on the road,” Nomura's Rochester adds.

All of the available indications suggest that if the government wants to continue on its current path, there’s little anybody could do to stop it. For a start it now has a much larger majority than it did before the 2019 election, when governing party members colluded with the opposition in parliament as well as the EU to frustrate and otherwise mitigate the UK’s exit from the bloc.

Most notably, the government is invoking parliamentary sovereignty, which is “the most important part” of the UK constitution, and Supreme Court judgement in R (Miller) v Secretary of State for Exiting the European Union.

When combined with a large 80 seat majority in the House of Commons, the obstacles that must be overcome for rebels, the opposition and the EU to stop the government could be insurmountable, which is not good news for Pound Sterling. Many analysts suggest that GBP/USD, the main Sterling exchange rate, could fall to around 1.15 in response to a ‘no deal’ Brexit.

This, even when combined with an underperforming in the New Zealand Dollar, would be enough to push the Pound-to-New Zealand Dollar rate off a precipice on the charts and back toward its post-referendum lows. Should the New Zealand Dollar’s broader performance improve in the coming weeks and months, GBP/NZD losses would become even steeper.

 Above: Pound-to-New Zealand Dollar rate shown at monthly intervals.

“Whether this is diplomacy or rogue state tactics remains to be seen but the damage has been done: idiosyncratic GBP risk has returned policy uncertainty is rising. We reiterate our bearish view on GBP heading into a crucial phase in Brexit negotiations and are positioning via short GBP/CHF. The risks of no deal have reason,” says Kamal Sharma, a strategist at BofA Global Research. “GBP is trading in a new post-Brexit paradigm. Recent price action supports our narrative that GBP is effectively trading like an EM currency.”

Sharma and the BofA team say the markets have been “far too complacent” in assuming that “common sense will prevail” and ultimately prevent an economic and political fracture between the UK and EU ahead of an ever closer December 31 end to the Brexit transition and self-imposed mid-October deadline for a free trade agreement to be struck.

They observe that since the referendum there’s been a deterioration in “liquidity conditions” that are closely connected to the overall level of trading activity within Sterling exchange rates and market participants’ perceptions of the risks that come with dealing in the Pound.

Deteriorating liquidity conditions are a recipe for heightened volatility Sterling exchange rates and a possible new paradigm for trading in the Pound-to-New Zealand Dollar rate which, once upon a time, would be found rising during bouts of volatility in broader financial markets.

There are now times however, where the GBP/NZD rate falls alongside stock markets and other risk assets in price action that could be symptomatic of those deteriorated liquidity conditions. In other words, trading in the Pound might increasingly become more directly comparable to trading in the South African Rand than the New Zealand Dollar or anything else.

 Above: GBP/USD rate shown at weekly intervals alongside NZD/USD (blue line, left axis).

“Carry signals have evaporated for GBP. Value signals still point to an undervalued pound but we continue to urge caution in over-interpretation. Trend indicators point to a sharp reversal in the fortunes of GBP but our major emphasis remains on the step deterioration in GBP liquidity,” Sharma says.

All of this adds up to dark days potentially being ahead for a GBP/NZD rate that would be found trading in line with ANZ’s 1.85 estimate in the first instance if Sterling continues falling out of bed, before falling to 1.8181 in the event that Nomura’s Rochester is right about a 1.20 GBP/USD rate being in the horizon.

However, the real rub for the British currency is that July 2017 lows of around 1.74, which are just less than -10% from Friday’s market, await if a ‘no deal Brexit’ of sorts becomes investors’ base case and others are right about this outcome pushing the GBP/USD rate down to 1.15.

That would result in a GBP/NZD rate of 1.74 if, like with the other above examples, NZD/USD continued to underperform and was unable to lift meaningfully from 0.66. Should the Kiwi outperform, all of the above referenced scenarios would come with heavier losses for Sterling.

"It looked like the markets no longer cared about Brexit! But that didn’t last and the pound has now weakened to $1.29 and €1.09," says Paul Dales, chief UK economist at Capital Economics. "Markets have woken up with a bang to the possibility that the Brexit transition period ends on 31st December without a deal. That could set back the UK’s economic recovery from the coronavirus recession and prompt the pound to weaken from $1.30 now to around $1.15."

GBP/NZD closely reflects price action in GBP/USD and NZD/USD combined.