New Zealand Dollar to Take Cue from RBA Decision

"NZD/GBP made a 3yr low overnight but watch GBP/USD as it’s struggled a bit in the past 24hrs too" - ANZ.

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The Pound to New Zealand Dollar exchange rate has climbed to post-pandemic highs in recent trade but the scope for new highs would potentially slip from within its grip if the Reserve Bank of Australia (RBA) surprises on the hawkish side of expectations in its interest rate decision next week. 

New Zealand's Dollar was an even bigger casualty than Sterling on Thursday when rallying U.S. bond yields lifted the bigger Dollar and kept the Kiwi under pressure near the lows reached after Australian inflation was said to have fallen sharply in May on Wednesday, leading antipodean currencies to fall.     

"The NZD has performed even worse, only partially explained by the flow of funds directed across the Tasman to pay for Taylor Swift tickets and associated travel costs for the Australian leg of her tour," says Jason Wong, a strategist at BNZ, in reference to the inflation figures out on Wednesday.

Falling inflation led financial markets to revise down expectations for the RBA cash rate in next Tuesday's decision while further lengthening the odds of another increase being announced by the Reserve Bank of New Zealand (RBNZ) on July 12.

Antipodean currency losses and a rebounding U.S. Dollar helped GBP/NZD remain near its best levels since April 2020 on Thursday but it could be susceptible to a setback next week if the RBA surprises with another increase in its cash rate.

Above: Pound to New Zealand Dollar rate shown at 2-hour intervals alongside NZD/USD and AUD/USD. 

"The Kiwi followed the AUD lower following softer AU CPI data yesterday and both have tentatively consolidated," says David Croy, a strategist at ANZ. 

"In fact, the next 7 days look like they’ll be shaped and led by the AUD given other data due there like retail sales, and given how barren the NZ data schedule is, and with the RBNZ on hold," he writes in Thursday market commentary. 

Falling inflation at the local level and the recent stability of interest rates in the U.S. and New Zealand have got financial markets looking for the RBA to take what would be a second break from raising interest rates next week after interrupting an earlier pause in its monetary tightening cycle by the benchmark to 4.1% earlier in June.

But the RBA cited rising services sector inflation elsewhere in the world and risk management considerations prominently among reasons for the June increase and with core inflation rates remaining upwardly biased in other major economies since then, there is high uncertainty over what the RBA will actually decide.

"We had previously pencilled in a hike in July, but softer than expected monthly inflation (driven by a sharp 8% fall in petrol prices) along with weaker consumer spending and confidence gives the Bank the opportunity to wait," says Izumi Devalier, an economist at BofA Global Research. 

"The Bank remains focused on striking the right balance between addressing price pressures and supporting full employment/ economic growth," she adds. 

Above: Pound to New Zealand Dollar rate shown at daily intervals alongside NZD/USD and AUD/USD.

Interest rate differentials have been an increasingly positive influence on GBP/NZD over recent months but would not be alone in supporting a continuation of its May rally if the RBA does take another breather next week as the antipodean currencies are currently hampered by multiple headwinds.  

"The forecast is for a final 25bp hike at the August meeting taking the cash rate to a peak of 4.35% for this cycle. With little additional news about a Chinese government economic stimulus package, the path of least resistance for AUD/USD remains down," says Kristina Clifton, an economist and currency strategist at Commonwealth Bank of Australia. 

Reports of a stuttering economic recovery in New Zealand's largest export market, China, and the creeping effect of past increases in the cash rate are just some of the other factors to have been cited for the recent underperformance of the Kiwi Dollar since the RBNZ suggested in May that it has finished raising borrowing costs.

"Central banks globally remain inflation-wary, particularly in the Eurozone and UK, with both the ECB and BoE some way off the end of their tightening cycles, particularly the UK. Interest rate differentials will work against the Kiwi," says Jarrod Kerr, chief economist at Kiwibank, who tips NZD/USD to reach 0.57 by year-end. 

Kiwi losses and a sharp increase in speculative buying of Sterling have helped keep GBP/NZD on an upward trajectory of late but the Pound itself could yet run aground up ahead if data coming from the UK economy leads to any second-guessing of the recently aggressive increase in expectations for the Bank of England (BoE) Bank Rate.

Above: Pound to New Zealand Dollar rate shown at weekly intervals with spread or gap between 02-year UK and New Zealand government bond yields. 

"GBP has performed well in the first half of June. But after last week’s Bank of England meeting, we find long GBP positioning is becoming stretched and our quant signals are turning bearish," says Vadim Iaralov, a quantitative strategist at BofA Global Research. 

"Latest CFTC data shows net long GBP positioning has sharply increased and now stands close to a five-year high (Exhibit 2). Despite the 50 bp rate hike, option flows have turned bearish for GBP vs both the EUR and USD," he adds in a Monday note. 

Implied expectations have surged in recent weeks to suggest a high probability of Bank Rate reaching 6.25% this year after inflation figures surprised on the strong side of expectations and some measures of labour market wage growth accelerated to new highs previously. 

But Governor Andrew Bailey suggested on Wednesday that market expectations could end up disappointed while Sterling has struggled to build further on its recent gains since the BoE raised Bank Rate from 4.5% to 5% last Thursday, suggesting scope for homegrown factors to potentially limit any additional GBP/NZD gains up ahead.

"NZD/GBP made a 3yr low overnight but watch GBP/USD as it’s struggled a bit in the past 24hrs too," ANZ's Croy warned on Thursday.