The Pound to New Zealand Dollar exchange rate continued its upward trend this week, reaching some of its highest levels since the beginning of the pandemic. However, there is now an increased risk of a correction in the exchange rate. This potential setback may become more likely in the coming days and weeks.
In the early part of the week, the New Zealand Dollar lost ground against most major currencies, including the Pound. However, the losses were not as significant as those observed after the Reserve Bank of New Zealand (RBNZ) interest rate decision last Wednesday.
Since the RBNZ's decision to raise its cash rate to 5.5% last Wednesday, the Kiwi Dollar has experienced losses. The central bank's updated forecasts indicate that the interest rate is likely to remain unchanged at its current level in the foreseeable future. Although this decision was in line with earlier forecasts, it was seen as 'dovish' compared to expectations that had increased following the government's announcement of increased investment spending and funding for post-disaster reconstruction in the recent annual budget.
For the week leading up to Wednesday, the New Zealand Dollar performed poorly compared to other advanced economy currencies, particularly against the U.S. Dollar and the strong Pound. In fact, the GBP/NZD exchange rate reached its highest levels since April 2020.
The rally in GBP/NZD was driven by the Office for National Statistics' data, which suggested that the decline in April's inflation may have been caused by previous drops in energy prices. The data also revealed an acceleration of inflation in the domestic sector of the economy. While overall inflation decreased from 10.1% to 8.7% last month, the core inflation rate, which is more significant, rose from 6.3% to 6.8%. Consequently, interest rate derivative markets indicated a high likelihood of the Bank of England (BoE) raising the Bank Rate from 4.5% to 5.5% this year.
However, this prospect poses a challenge for the Sterling, as the increased expectations for the Bank Rate could impact the UK economy. Mortgage rates are based on the market-implied rate rather than the actual Bank Rate. Therefore, households can expect to pay 5.5% or more when renewing fixed-rate mortgages, which is significantly higher than the average level of 0.1% to 0.75% seen over the past 15 years. This implies that monthly mortgage repayments could consume a substantial portion of some incomes.
Furthermore, there are concerns about the cooling labour market and projections that the UK economy will underperform many of its counterparts this year. Additionally, reports suggest that speculative traders have heavily invested in Sterling, making it vulnerable to profit-taking.
