Pound-New Zealand Dollar Rate Risking Short-lived Slide to 1.93

- GBP/NZD could see imminent slide back to May lows
- With NZD finding feet while GBP doths its cap to BoE
- But losses may be short-lived until AUD & EUR recover

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• GBP/NZD reference rates at publication:
• Spot: 1.9450
• Bank transfers (indicative guide): 1.8770-1.8905
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The Pound-to-New Zealand Dollar rate may be at risk of a slide toward May lows around 1.93 ahead of the weekend but such losses could prove short-lived if downtrends in the Australian Dollar and Euro persist.

Sterling and the New Zealand Dollar were the worst performing major currencies in the G10 segment of the market for the week to Wednesday when GBP/NZD was little changed for the period while trading around 1.9420.

Pound Sterling’s losses elsewhere are potentially a reflection of risks posed by Thursday’s monetary policy decision from the Bank of England, in which the market will look to see how the BoE interprets recent economic data that includes disappointing retail sales and GDP figures for July.

Those figures followed a second quarter in which the UK economy performed strongly, though not quite as strongly as the BoE had anticipated.

“The underperformance compared to higher-beta currencies might suggest markets have turned less confident the BoE will be able to stick to its broadly optimistic tone as it announces policy tomorrow,” says Francesco Pesole, a strategist at ING.

The BoE warned in August that UK inflation could rise to four percent or more this year and was frank in its admission that it may be necessary to raise Bank Rate from 0.10% to 0.5% or more over the coming years in order to return the consumer price index to the 2% target.

Above: Pound-to-New Zealand Dollar rate shown at daily intervals with major moving-averages and Fibonacci retracements of 2021 rally indicating possible areas of support.

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"BOE expectations have moved most markedly in the hawkish direction since Jun, so much so that the rate hikes are priced in earlier in 2022 than the other major central banks under study. Interestingly, there has been a divergence in BOE expectations and GBP performance during this period," says Terence Wu, an FX strategist at OCBC Bank in Singapore.

"A question remains over the sustainability of this divergence," he adds.

The more recent concern in some parts of the market however, has been that July data could lead the BoE to perceive a lesser need for rates to rise in quarters ahead, even though it’s far from a foregone conclusion that it would change its outlook based upon one month’s worth of figures.

Even more so given that the above data relates to a period in which economic figures were always expected to be volatile, although Sterling has weakened nonetheless and put GBP/NZD at risk of falling to 1.93, especially in light of Wednesday’s rebound in the main Kiwi exchange rate NZD/USD.

GBP/NZD closely reflects the relative performance of the main Sterling and Kiwi exchange rates GBP/USD and NZD/USD, and would fall further over Wednesday and Thursday if the latter retained its nascent upward trajectory and Sterling remained under pressure into the BoE’s decision.

"Monday’s RBNZ speech was interpreted as reducing the chance of a 50bp hike, slightly depressing the NZD, although we read the speech as simply an education piece on the 'least regrets' framework for monetary policy decisions,” says Imre Speizer, head of NZ strategy at Westpac.

“Global risk aversion and a perky USD are the main drivers at present," he adds.

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NZD/USD rallied in the mid-week session alongside global stock and commodity markets while Sterling clocked up further losses, and would push GBP/NZD as low as 1.93 if the rally takes NZD/USD back to its 100-day average around 0.7067 and if at the same time GBP/USD is unable to lift meaningfully off of Wednesday’s 1.3640 level.

Such losses could ultimately prove to be short-lived however, and for reasons relating to Reserve Bank of New Zealand (RBNZ) monetary policy.

This is because the Bank has assumed that the overall New Zealand Dollar - known as the trade-weighted New Zealand Dollar - will remain flat over the coming years even as it lifts New Zealand's benchmark interest rate from 0.25% to a little over 2% by early 2024.

“NZD/USD has pushed back above the 0.70 level, having dipped its toe below this psychological level in the past couple of sessions,” says Jane Foley, head of FX strategy at Rabobank.

"We are constructive on the medium-term outlook for the NZD, but see scope for NZD/USD to dip back below the 0.70 level on a 1 to 3 month view,” she says.

Monday’s speech by Assistant Deputy Governor Christian Hawkesby was taken by many in the market as an indication that the RBNZ is unlikely to lift the cash rate by any more than 0.25% following its October 06 meeting, and was widely cited by analysts as a contributor to earlier falls in NZD/USD.

This was after bank staff suggested repeatedly through August and early September that the RBNZ is still likely to begin a cycle of interest rate rises as soon as October’s meeting, which has been supportive of the Kiwi Dollar and a significant weight on GBP/NZD in the recent month.

Above: NZD/USD shown at daily intervals with major moving-averages and Fibonacci retracements of March 2021 downtrend.

The rub for the Kiwi and consolation for Sterling is that the RBNZ’s assumptions about the trade-weighted New Zealand Dollar potentially create constraints for the likes of NZD/USD, NZD/AUD, NZD/CNH and NZD/EUR, especially now the bank’s cycle of interest rate rises has been ‘priced-in.’

The interest rate cycle was already enough to ensure that Kiwi inflation returns to the midpoint of the 1% to 3% target range by the end of the cycle, but would become less necessary if the trade-weighted Kiwi Dollar continues to rise in the manner that it has done since August’s meeting.

The RBNZ’s trade-weighted Kiwi Dollar index edged higher from 74.4 to 74.8 between the August meeting and September 22, although gains in this index can reduce import costs and inflation rates, in turn impairing the argument for higher interest rates and ironically, the outlook for the Kiwi.

This recent appreciation left the index above the 74.4 level assumed by the RBNZ with the largest contributors being declines in the U.S. Dollar (13.6%), Australian Dollar (18.7%) and Euro (10.41%), which are the three largest constituents of the index after the Renminbi (23.47%).

It’s possible that this price action implies something about the outlook for NZD/USD and in turn, GBP/NZD, especially so if multi-month downtrends in the Euro and Aussie are to remain in place during the weeks ahead.

Further increases in NZD/AUD and NZD/EUR would lift the trade-weighted Kiwi further and could tarnish the case for as many RBNZ rate rises as have been priced in by the market for the coming years, unless the price moves are offset by losses in the likes of NZD/USD, NZD/CNH or others.

To the extent that these dynamics frustrate further gains in NZD/USD or lead to outright losses in the weeks ahead, they could limit declines GBP/NZD or perhaps even lift it due to the substantial direct influence that NZD/USD has on its overall level.

Above: Major components of trade-weighted New Zealand Dollar index shown at daily intervals.