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
3
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
4
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
BNZ MARKETS
5
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%
BNZ MARKETS
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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
BNZ MARKETS
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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
BNZ MARKETS
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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%
BNZ MARKETS
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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)
BNZ MARKETS
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
BNZ MARKETS
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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
BNZ MARKETS
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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
Disclaimer