MENU

The Pound-to-New-Zealand-Dollar Rate is a Buy at Westpac

Above: RBNZ Governor Adrian Orr. File Image © Pound Sterling, Still Courtesy of Financial Services Council NZ

- GBP/NZD rate set for gains, is tipped as a buy at Westpac.

- RBNZ rate cut call brought forward, market yet to price it in.

- As changing of guard in Westminster prompts GBP bounce.

- But Brexit and election risks are high, threaten fresh losses.

The Pound is set to extent its nascent recovery against the Kiwi Dollar as the Reserve Bank of New Zealand (RBNZ) cuts its interest rate faster than the market expects later this year, according to analysts at Westpac, who've told corporate clients to buy the exchange rate. 

Pound Sterling has crept higher this week after Boris Johnson won the Conservative Party leadership election, setting him up to replace outgoing Prime Minister Theresa May in 10 Downing Street late Wednesday. Price action has been the polar opposite of what some pundits projected but steep losses wracked up before the result of the leadership election have meant there was already a lot of bad news in the price of the Pound. 

Johnson could yet manage to secure an amicable as well as orderly exit from the EU, which is why some traders have begun buying back currency they previously sold in order to crystalise some of their profits. But risks are high for the Pound because the Conservative Party majority is slim and opponents of Brexit within the party have conspired with the opposition to bring down the government in the event that a 'no deal' Brexit looks likely at any point. 

Nonetheless, the Westpac team say the Pound-to-Kiwi rate is likely to go on rising, aided by developments on the ground in New Zealand.

Above: Westpac graph showing GBP diverging from bond yields as Brexit fears rise in Q2 2019.

"There is a possibility that the RBNZ could cut the OCR in September, and even a possibility that the OCR could drop below 1%. A slowdown in the New Zealand economy has been in train for almost two years now," says Westpac's Dominic Stephens. "We previously expected that the economy would be picking up by mid2019, on the back of fiscal stimulus and lower interest rates. Instead, recent data suggests that New Zealand economic growth has remained slow." 

Westpac changed its forecasts for New Zealand interest rates this week and now says the RBNZ is likely to cut its cash rate to a fresh record low of 1.25% in August before following up with a further reduction in the benchmark lending rate in November, taking it down to 1%. Previously, Westpac had looked for only one more cut to come, in August, and its new forecasts are not yet reflected in the Kiwi interest rate market. 

Pricing in the overnight-index-swap market implied on Thursday an August 07 cash rate of 1.28%, which is close to but not the same as the 1.25% rate that would prevail in the even the RBNZ cuts again. The rate implied for November 13 was 1.07%, which is also above the 1% that would prevail in the event of a second additional cut. The Kiwi Dollar normally follows these implied rates so if the market comes around to Westpac's view at any point in the near future it could hurt the New Zealand Dollar.

The RBNZ is obliged to use interest rate policy to ensure inflation, which is sensitive to growth, averages around 2% over the medium term. Changes in rates impact currencies because of the influence they have over capital flows. Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. 

Above: Pound-to-Kiwi rate at daily intervals, with 2-year GB-NZ bond yield spread (green line, left axis).

"Yield spreads have explained much of the NZD’s recent gains, but they may soon become a headwind. Technically, GBP/NZD is at a multi-year head-and-shoulders neckline – a sustained rebound would target at least 1.9500," says Richard Franulovich, head of FX strategy at Westpac. "Markets are pricing 20bp of easing in August, and 42bp by November, implying markets should fall further if our forecasts prove correct."

The "yield spread" that have helped the Kiwi higher against many of its rivals in recent weeks fell from grace as an influence on Sterling a long time ago, even if this divergence has picked up since May. The difference between the exchange rate level implied by "yield spreads" and the market reflects a Brexit-related 'risk premium'.

The Reserve Bank of New Zealand has been battling against below-target inflation for years only now the economy is slowing in response to both domestic factors as well as the impact President Donald Trump's trade war with China has had on the global economy. Many forecasters say Kiwi growth, as well as the global economy, will slow even further during the second half of 2019. 

Inflation is influenced by many things including economic growth so the weak outlook for demand could mean the RBNZ faces and even taller order to get the consumer price index sustainably into the upper end of the 1%-to-3% target band. This is why Westpac is warning that even its own below-consensus forecasts for Kiwi interest rates might not be low enough. 

Franulovich told Westpac clients to buy the Pound-to-Kiwi rate at 1.8615 early on Thursday and to target a move up to 1.91 in the coming weeks and months. The exchange rate was quoted above 1.87 late in the noon session, although Franulovich says Westpac will walk away from the punt on the British currency if the market falls below 1.8450 at any point. 

Above: Pound-to-Kiwi rate at daily intervals, with 2-year GB-NZ bond yield spread (green line, left axis).

 

BannerTime to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

* Advertisement

GBP/NZD download banner

Sirelo banner