NZD/GBP

BNZ MARKETS

Jason Wong, Senior Markets Strategist

11 February 2019

BNZ MARKETS

Summary

2

• GBP is super-cheap, driven down by Brexit uncertainty.

• Long term fair value for NZD/GBP is 0.43.

• Our short-term model suggests that in the absence of Brexit, current fair value is around 0.47-0.48.

• Brexit outcomes remain a key source of uncertainty for NZD/GBP.

• We assume a soft Brexit outcome that drives the cross down to 0.48 this year.

BNZ MARKETS

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Technical picture • The cross has traded a wide

range over recent years and been volatile at times, with Brexit a key contributor.

• We judge a downward channel has been in play over the last couple of years.

• Bottom/top of channel is currently 0.4780-0.5460.

0.40

0.44

0.48

0.52

0.56

0.60

2012 2013 2014 2015 2016 2017 2018 2019

NZD/GBP

Source: BNZ, Bloomberg

BNZ MARKETS

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Long-term valuation model • The cross has been trading

above our long-term purchasing power parity estimate for the best part of 15 years, reflecting strong NZ relative terms of trade.

• This dynamic should be sustained; we see NZ’s terms of trade remaining strong.

• We usually prefer to use a 15-year moving average filter for our PPP estimates, but for this cross a longer time period seems more appropriate.

• Our PPP-25yr model estimate currently sits close to 0.43.

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

0.65

1996 1999 2002 2005 2008 2011 2014 2017

PPP-15

NZD/GBP

2 stdev error bands

Source: BNZ

PPP-25

Model

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Economic Growth • NZ and UK GDP per capita

growth rates have tracked closely together over the past five years.

• Brexit uncertainty has likely weighed on UK growth, but this has come at a time of a weaker NZ growth profile.

• While NZ growth is expected to track close to trend over the year ahead, for the UK the outcome will depend on how Brexit plays out over coming months.

-8

-6

-4

-2

0

2

4

6

2000 2002 2005 2007 2009 2012 2014 2017

Real GDP per capita

NZ UK

Source: BNZ, Bloomberg

Y/Y%

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Economic Sentiment Indicators • Economic sentiment

(combining business and consumer confidence) is running stronger in the UK than NZ, despite Brexit uncertainty.

• In fact, UK economic sentiment, while slipping, is still above average.

• The NZ index has been weighed down by weaker business confidence since the September 2017 election.

-4

-3

-2

-1

0

1

2

2000 2002 2004 2006 2008 2010 2013 2015 2017

Economic Sentiment Indicators

Source: BNZ, Bloomberg

NZ

UK

Normalised indices (z-scores).

For UK: European Commission

index; For NZ: Avg of ANZ

consumer confidence and

z-score

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Unemployment Rates • GDP growth in both countries

has been strong enough to drive down unemployment rates over the past five years.

• Over the last few years, the rate of decline in the unemployment rates has been at a similar pace.

• In both countries, unemployment rates are around the 4% mark.

0

1

2

3

4

5

6

7

8

9

2000 2002 2004 2006 2008 2010 2013 2015 2017

Unemployment Rates

Source: BNZ, Bloomberg

NZ

UK

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Inflation • The BoE has had more success

in meeting its 2% inflation target than the RBNZ over the past couple of years, although the impact of the weaker GBP after the Brexit vote has now faded.

• NZ core inflation is rising, albeit slowly, towards 2%.

0

1

2

3

4

2005 2006 2008 2009 2011 2012 2014 2016 2017

Core CPI Inflation

Source: BNZ, Bloomberg

NZ (RBNZ sectoral factor

model)

UK

Y/Y%

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Monetary Policy • The market is currently pricing

almost a full 25bp rate cut in NZ by the end of this year.

• The market sees a small chance of higher UK rates over the next couple of years.

• On our core view of a soft (or no) Brexit outcome, we see the risk of higher UK rates.

• We also see the risks weighed towards higher NZ rates compared to dovish market expectations.

0

1

2

3

4

2012 2013 2014 2015 2016 2017 2018 2019 2020

RBNZ vs BoE Policy Rates

Source: BNZ, Bloomberg

NZ OCR

UK Bank Rate

Y/Y%

Market Pricing

BNZ MARKETS

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Interest Rate Differentials • The relationship between NZ-

UK interest rate differentials and the cross is not strong.

• Indeed, when included with other factors in an NZD/GBP fair value model, rate differentials don’t add any value.

• NZ-UK real rate differentials are close to historical lows.

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

0.40

0.45

0.50

0.55

0.60

0.65

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

NZD/GBP vs NZ-UK Real 2-Yr Swap

Source: BNZ, Bloomberg

NZD/GBP (lhs) NZ-UK Real 2-yr

(rhs)

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11

Commodity Prices • There is a positive relationship

between NZ commodity prices and the cross rate.

• Over the past couple of years, NZ commodity prices have largely tracked sideways.

• Current momentum is slightly to the upside, as dairy prices recover and demand for soft commodities remains robust.

60

70

80

90

100

110

120

0.40

0.42

0.44

0.46

0.48

0.50

0.52

0.54

0.56

0.58

0.60

2010 2012 2014 2016 2018

NZD/GBP vs NZ Commodity Prices

Source: BNZ, Bloomberg

NZD/GBP (lhs)

NZ Commodity

Prices in USD

(rhs)

BNZ MARKETS

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Short Term Valuation Model • Brexit uncertainty has had a

long-lasting negative impact on GBP.

• If not for Brexit, our fair value model suggests that the NZD/GBP “should” be trading around 0.47-0.48.

• A soft Brexit or no Brexit would likely see the spot rate fall towards the model estimate, closing the gap.

0.40

0.42

0.44

0.46

0.48

0.50

0.52

0.54

0.56

0.58

0.60

2010 2012 2014 2016 2018

NZD/GBP Model

Source: BNZ, Bloomberg

NZD/GBP (lhs)

Model estimate

(rhs)

Brexit

Factors: Risk appetite, NZ commodity

prices and relative economic sentiment

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Brexit Risks – Two-sided for the Cross Lots of permutations: Here are some key ones with possible currency targets once the dust settles:

• PM May’s EU Withdrawal Agreement (or something close to it)

Our central view, a soft Brexit, NZD/GDP 0.47-0.49

• Eventual second referendum; Brexit avoided

Our next-best guess, NZD/GBP 0.43-0.47

• A less benign outcome to May’s deal eg Norway+ or Canada style FTA

Brexit but with less benefits, NZD/GBP 0.54-0.56

• No-deal; WTO rules apply; Uncertainty over rules prevails

Little Parliamentary support for this, NZD/GBP 0.59-0.63

• General election; currency crisis

Possible if things get out of control, NZD/GBP 0.62-0.65

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Forecasts • Brexit is the key driver of our

forecasts.

• We assume a soft Brexit outcome that drives the cross down to 0.48.

• Timing remains somewhat elusive, as some delays in removing the fog of Brexit could occur.

• As the previous slide shows, a wide range of outcomes is still entirely plausible, with a move above 0.60 on the worst scenarios.

0.30

0.35

0.40

0.45

0.50

0.55

0.60

2005 2007 2009 2011 2013 2015 2017 2019

NZD/GBP

Source: BNZ, Bloomberg

Forecast

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