Pound to New Zealand Dollar Forecast: A Return to 2.32 as Lending Restrictions are Expanded by RBNZ

Pound to New Zealand Dollar Forecast: A Return to 2.32 as Lending Restrictions are Expanded by RBNZ

20 April 2016, 21:11
Vasilii Apostolidi
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Low inflation and subdued dairy prices will keep the New Zealand dollar in check over the course of the coming year.
The pound sterling remains in a protracted downturn against the New Zealand dollar with the pair about to give up all the gains made in 2015.

The declines appear to be targeting the range that lies 100 pips either side of the psychologically significant 2.0 area.

This zone held the GBP/NZD from mid-2014 through to mid-2015 and is clearly gravitational.

Why is this move happening?

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There are a number of factors to consider when appreciating the GBP to NZD rate’s determined move lower:

New Zealand’s base interest rate at 2.25% is still one of the highest in the developed world and therefore attracts notable capital inflows
The Bank of England meanwhile looks unwilling to raise the UK’s basic rate above 0.5%. Would you turn down the chance to borrow money at 0.5% and plonk it somewhere that offers a yield of 2.25%? This promise of free money helps explain why GBP is being exchanged into NZD.
The EU referendum is acting like a lead life jacket around sterling; until the outcome of the vote is known we should expect one-way traffic.  
However, one thing is certain - the GBP/NZD is not going to continue on this trajectory nor will it be where it is now in a year’s time.

Indeed, analysts at Ebury Partners, a contributor to Bloomberg's foreign exchange polls, have told clients that the area GBP/NZD is likely to ultimately gravitate towards is 2.32.

Ebury are worth listening to as their forecasts have topped the Bloomberg polls for accuracy at various points in the past.

Ebury reckon the NZ dollar’s period of appreciation will ultimately stall with much of the work being done by the Reserve Bank of New Zealand (RBNZ).

The RBNZ claimed in March that further policy action may now be required in order to ensure inflation meets its medium-term target.

 Markets are currently pricing in another rate cut in New Zealand around the third quarter of this year.

Cutting interest rates again will diminish that interest rate advantage we mentioned and could well slow investor flows.

One of the glaring reasons why the RBNZ will have to act on interest rates is the dairy sector which continues to suffer the effect of historically low prices.

Dairy prices remain over 40% lower than two years previous in USD terms.

“As well as driving down inflation expectations this has worsened New Zealand’s terms of trade, given dairy production accounts for around 40% of the country’s overall export revenue. Economic growth has also moderated, albeit remains relatively solid having registered a larger-than-expected 2.3% in annualised terms in the fourth quarter,” says a forecast note from Ebury.

As a result, net farmer confidence has turned decidedly pessimistic again in 2016 according to a recent ANZ survey.

A net 46% of farmers surveyed in March were pessimistic regards the overall business outlook for the coming year.

This is well down from the net 8% that were optimistic at the end of last year. Farmer confidence is well below its long term average.

This is one sector that could use the help of lower financing costs, and the RBNZ would gladly oblige as any cuts to rates would also likely slow unwanted NZD appreciation.

There are even more reasons why the RBNZ would want to stamp on the interest rate: global events have thrown another curve ball the RBNZ’s way.

Namely, European economic weakness has weighed heavily on European banks, leading to an increase in global bank funding costs.

This increase culminated in local banks not passing through to floating rates the full amount of the March OCR cut.

“Normally these factors would make the case for further prompt OCR cuts clear, but the re-heating housing market has complicated the outlook,” says Nathan Penny, Rural Economist at ASB in Aukland.

And therein lies the problem, the RBNZ is being held hostage by a red hot property market.

With interest rates historically low, nationwide house sales jumped nearly 5% over March. And the jump in sales coincided with the nationwide stratified median sales price lifting 13.3% compared to March 2015.

Housing Market Headache

With the housing market reigniting, the Reserve Bank’s investor and other housing restrictions are beginning to seem “long ago”.

The Auckland-centric investor restrictions, for example, have simply sent some investors further afield.

“Some data suggest that Auckland investor buyers accounted for circa 20% of Whangarei and Tauranga sales over the first three months of the year,” says Penny.

The RBNZ Will Still Cut

So the question is, how does the RBNZ push inflation back to target without further stoking the housing market?

“If housing data over coming months confirm the re-acceleration, then we expect one way could be to broaden the investor restrictions later in the year from ‘Auckland only’ to nationwide. Alternatively, the investor deposit requirement of 30% could lift to say 40%,” says Penny.

These increased restrictions would free up the RBNZ to make the 50bps of OCR cuts that ASB expect in June and August this year.

The above housing complications, as well as the slightly stronger Q1 inflation data, suggest that the RBNZ may see little urgency to cut rates.

“In saying this, we cannot completely discount an April cut,” say ASB.

Forecasts for the New Zealand Dollar

Ebury believe the delivery of lower rates in New Zealand will ultimately play out for subdued New Zealand dollar.

The pound to New Zealand dollar exchange rate is forecast to rise to 2.32 by the third quarter of 2016.

The rate is likely to pivot around this level through to the end of 2017.

Against the US dollar we see NZD/USD is forecast to move to 0.63 by the end of 2016 and is likely to trade around here through to the end of 2017.

So it is too early to suggest the rate is going back to its 2014-2015 comfort zone.

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