Sterling set for a fall if New Zealand rate hike goes wrong

Sterling could fall victim to the central bank of … New Zealand, David Bloom, global head of foreign exchange research at HSBC, has warned.

The Reserve Bank of New Zealand (RBNZ) became the first central bank of a developed nation to raise interest rates this year.

It lifted its official cash rate (OCR) by a quarter of a percentage point to 2.75%. Governor Graeme Wheeler said the OCR could increase by a total of 1.25 percentage points this year.

The Bank of England is probably next in line to raise interest rates in the developed world, with interest rate futures signalling the first hike early next year, before the US Federal Reserve and the European Central Bank, Bloom said in a research note.

“In a world where central banks will be trying to exit unprecedented monetary accommodation, the RBNZ experience will be closely followed,” he said.

If the tightening cycle announced by the New Zealand central bank can go ahead without “derailing the economy or destabilising financial markets,” then expectations for UK interest rates are unlikely to be affected.

But if the hike in rates has “unexpected and swift” negative effects, investors will reduce their expectations for the future pace of tightening in New Zealand. The impact, however, will not be confined to that country.

Such negative consequences would show that an economic recovery should be more entrenched before interest rates increase.

“Given the close association between UK rate expectations and the performance of GBP, a New Zealand-induced retreat in the market’s forecast of the BoE’s interest rate path would see GBP sharply lower,” Bloom warned.

Investors will also look at how the central bank of New Zealand balances monetary tightening with the strengthening it could cause to the currency. “Excessive strength” is likely to slow down the pace of interest rate increases.

Bloom noted that in Britain, comments from Bank of England members already reflect concerns that the strength of the pound, brought on by expectations of further monetary tightening, is “undermining the rebalancing of the UK economy away from consumption.”

@AntoniaOprita