GBP/NZD Rate at Risk of Setback to 1.94 or Below

• GBP/NZD topping out & at risk of correction
• Setback could see GBP/NZD back near 1.93
• As NZD/USD pares back heavy April losses 
• Aided by a softer USD and recovery in RMB
• UK CPI data & NZ budget key for GBP/NZD

Image © Adobe Stock

The Pound to New Zealand Dollar exchange rate reached its highest level since shortly after the Russian military first crossed into Ukraine early in the new week but may be in the process of topping out and could be at risk of a corrective setback in the days ahead.

Sterling outperformed most G20 counterparts on Tuesday following the release of labour market figures that showed the UK unemployment rate falling to a 50-year low while also suggesting that wage growth may be catching up with inflation in some parts of the economy. 

“The pound is the best performing G10 currency on a 1 day view as stronger than expected UK labour data raised the prospect that the BoE may have to go further with policy tightening to rein in inflationary pressures,” says Jane Foley, head of FX strategy at Rabobank.

“While a strong labour market is a good reflection of economic health, it is not good news for everyone insofar as higher interest rates will compound the impact of the cost of living crisis for many lower income households,” Foley also said in a Tuesday review of the outlook for Sterling.

Tuesday’s data is likely comforting for Bank of England (BoE) policymakers and was read by the market as supportive of expectations for further increases in UK interest rates later this year, hence the rally in the Pound.

Above: Pound to New Zealand Dollar rate shown at daily intervals alongside GBP/USD and NZD/USD. Fibonacci retracements of February fall indicate possible short and medium-term areas of technical resistance for Sterling and support for the Kiwi. Click image for closer inspection.

But it’s possible that GBP/NZD is already running out of road because Tuesday also saw the U.S. Dollar easing notably from recent highs against many currencies including the New Zealand Dollar and some analysts see NZD/USD as likely to advance further in the days ahead.

“NZD/USD reached our downside target of 0.6230 on 12 May with the 0.6217 low possibly marking the end of a decline since February 2021. Technically it appears so - the decline retraced a classical 62% of the Mar 20-Feb 21 rally, and price-momentum divergence was confirmed this week. For the week ahead, we target 0.6400 or higher,” says Imre Speizer, head of NZ strategy at Westpac.

“All the major drivers on NZD/USD have weighed on NZD/USD over the past month, with the USD, yield spreads, and risk sentiment weighing for much of this year. There are tentative signs that the USD and risk sentiment may be at or near a turning point. And yield spreads may get a boost next week if Westpac’s forecast for a 50bp hike and 3.50% peak rate by August is endorsed at the RBNZ MPS on 25 May,” Speizer also said on Tuesday.

Above: NZD/USD shown at daily intervals with Fibonacci retracements of April fall indicate possible areas of technical resistance for the Kiwi and support for the U.S. Dollar. Featured alongside 02-year U.S. government bond yield and Renminbi-Dollar exchange rate.

The Pound to New Zealand Dollar exchange rate is sensitive to developments in NZD/USD and often tends to struggle for traction when the latter is rising, which it could do later this week if Thursday’s budget announcement in Wellington provides the Kiwi currency with a further boost.

“They are in a tricky spot. On the one hand, the economy is clearly very overheated, but on the other, there are long-term challenges around infrastructure, health, and climate change which need to be addressed,” writes Sharon Zollner, chief economist at ANZ, in a recent research note.

"The cyclical position of the economy points to aneed for restraint, but the structural challenges we face will require significant ongoing investment for decades. Whatever the Government decides, it’ll then be up to the RBNZ to set monetary policy to restore price stability," Zollner and colleagues also said.

Above: Market-implied expectations for Reserve Bank of New Zealand and Bank of England interest rates. Source: ANZ. Displayed as two separate images. Click each image for closer inspection.

There is a risk, if not a likelihood, that new spending and investment initiatives announced on Thursday will bolster market expectations for the Reserve Bank of New Zealand (RBNZ) to announce further large 0.50% increases in its benchmark interest rate later this year.

That would be supportive of the recovery in NZD/USD and could potentially rein in Sterling even if Wednesday's UK inflation data also incites further market optimism about the outlook for Bank of England (BoE) interest rates.

This is in part because the BoE might still be unlikely to meet market expectations for Bank Rate even if the April data points to a further build up of inflation pressures in the UK and despite Tuesday’s jobs figures.

Meanwhile, the Kiwi could also continue to draw support from a tentative rebound by the Renminbi, which rose sharply on Tuesday as China’s largest city and the nerve centre of the global manufacturing industry, Shanghai, headed for a phased reopening from a coronavirus-induced 'lockdown'.

The Kiwi had come under significant pressure in April when the Renminbi began to reverse an almost two-year uptrend against the U.S. Dollar, which lifted the greenback further while weighing on many other currencies.