GBP to New Zealand Dollar Forecast to Grind Higher, But Yield Should Keep NZD Losses Limited

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The outlook for the New Zealand dollar exchange rate complex for the week ahead suggests further losses however analysts do caution that weakness should ultimately be contained by the country's superior interest rate.

After being in a strong short-term up-trend, the pound to NZ dollar conversion could pause to consolidate in the week ahead. 

The exchange rate pulled-back sharply after reaching a peak of 2.1778 on Thursday May 19, falling back down to end the week at 2.1416.

Nevertheless, the break above the key 2.1493 level was a very bullish medium-term sign and increased the chances that a new up-trend was in the process of forming.

Therefore, the current correction is probably just a short-term phenomenon and the young up-trend is likely to resume once it is over.

It is possible it may move back as far as support from the basing pattern’s ‘neckline’ at 2.1300, before reversing and going higher again.

There could be an inverse head and shoulders (H&S) bottoming pattern at the lows, which is another strong bullish reversal sign.

From a technical perspective we see more gains on the horizon once the correction has finished, with a break above the current 1.1778 highs, confirming more upside to a fresh target at 2.1886, at the R2 monthly pivot. 

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NZ Dollar Vulnerable vs USD and AUD

NZD/USD is in a tug-of-war as both the local and US markets reassess central bank outlooks, to be now more in tune with our house view (no-change RBNZ in June and a Fed hike in June/July).

This dynamic looks set to continue argue ANZ Research who cite two reasons:

a) We do not expect USD strength to be as overt this time, as USD strength is an area the Fed is concerned about;

b) The RBNZ will remain dovish despite our expectation of no change.

However, ANZ do warn that over the longer-term the NZD should continue to find latent support from New Zealand's superior interest rate.

With a basic rate set at 2.0% New Zealand continues to attract foreign capital, particularly when you note the Eurozone is subject to negative rates and the UK to 0.5%.

ANZ have noted time and time again, monetary policy is now implicitly being expressed through currencies and that makes them divergent from localised fundamentals.

In that world there will be pressure for interest rates to converge to keep exchange rates within acceptable bounds.

"The performance of the NZX and commercial property market (declining cap rates) is reflective of an insatiable thirst for yield, any yield, in a world of more and more negative rates. And those flows are NZD supportive," say ANZ.

Budget Dominates Coming Days

On May 26 the 2016/17 budget for New Zealand takes place.

Data available to date suggest that the budget is more or less balanced for 2015-16 and hence we see little alteration to the forward estimates, and therefore the bond issuance program of $NZ9b pa.

Growth is solid, while a low inflation environment limits upside to revenue growth. Net debt peaked at just over 26% of GDP.

NZD Themes to Watch

The kiwi is likely to hold firm due to lessening expectations of another interest rate cut by the Reserve bank of new Zealand, after Dairy prices rose by 2.6% at the Global Dairy Auction on Tuesday.

The New Zealand Dollar is still in demand due to its advantage over other G10 economies, over which it has the interest rates, at 2.25% - much higher than the UK’s 0.50% or the Eurozone’s 0.00%.

These high interest rates attract a lot of foreign investors who park their money in New Zealand to gain from the higher interest rates, this increases demand for the kiwi.

The economy is reasonably strong except for the large dairy sector which has seen its revenue collapse due to plummeting global dairy prices. RBNZ governor Wheeler went so far as to mention this in a recent speech. However prices have stabilized over the last month with the last Global Dairy Auction registering a 2.6% rise in prices.

Traditionally, low dairy prices have prompted the RBNZ to devalue the kiwi via the vehicle of reducing interest rates, however, that risk is lower now.

A risk factor is the growing housing bubble, which is a disincentive for the RBNZ to reduce interest rates, as that would make borrowing cheaper and increase the bubble. Auckland now is one of the most expensive places in the world to live using a comparison of house prices to income.

Some analysts have suggested this means the RBNZ will not lower rates in the current cycle because of the housing boom.

The pair, therefore may pause or go sideways in the short-term as sterling finishes its Brexit-loss recouping upswing, now that it has regained a substantial amount of ground.

According to the BOE, who estimate Brexit losses to have amounted to about 5% of the fall in sterling in the last 6-months, that loss has now almost completely been reabsorbed at the current level.

Other estimates which place the premium higher, such as UniCredit’s 8% of Sterling’s losses (in the GBP/USD pair), which would require a move back up to 1.49 (GBP/USD) to recover, indicate more upside may still be in the pipeline - indeed it’s hard to believe that at current levels everything has been reabsorbed before the referendum has even taken place!

What does seem possible is that the ‘low hanging fruit’ of Brexit losses may now have been picked and the remainder of the risk premium may be harder to reach. Still CFTC data from US Futures Exchanges is still showing a predominance of short Sterling positions still remaining after they reached a record high at the height of the Brexit bear market, which could still fuel a short-covering rally higher. 

Now that concerns about Brexit have calmed down with the ‘Remain’ campaign comfortably in the lead, attentions are being turned to more quotidian concerns of when the UK central bank will decide to raise rates (or indeed possible cut them).

In this sense the UK is in a similar position to the US where attentions are being concentrated anew, on data, so as to gauge growth; likewise, in the UK something similar has been starting to happen.

Much was made of Thursday’s stellar Retail Sales release as it helped dispel fears the UK economy was weakening.

April Manufacturing PMI actually came out in contraction mode for the first time in years, and Q1 growth was lower than the eurozone, therefore analysts will be awaiting UK Q1 GDP second estimates on Thursday with much anticipation.

It is not expected to be revised from the current 0.4%, but if it is, either up or down, this will probably impact rate hike expectations and therefore the pound.

Data Hotspots

The New Zealand Trade Balance on Tuesday is expected to show the deficit widen to -3.94bn yoy from -3.38bn previously. Anything worse is likely to be kiwi-negative, as it will put pressure on the RBNZ to consider cutting interest rates to devalue the kiwi, to help exporters.

For the pound, the main data release will be GDP second estimates on Thursday, which are expected to remain at 0.4% in line with expectations.