Should You Invest In GBP/NZD?

• The British pound is an international reserve currency held by central bankers around the world and used to underpin the operations of the International Monetary Fund.

• The New Zealand dollar is essentially a domestic currency, albeit one issued by a stable and prosperous democracy.

• Both currencies are the responsibility of independent central banks that are free to set interest rates to control inflation. Indeed, the Bank of England’s monetary policy regime is modelled on that pioneered by the Reserve Bank of New Zealand.

• Britain’s economy is very much larger than that of New Zealand, with gross domestic product of $2.8 trillion against $0.18 trillion.

• While economic ties are not as close as they were, financial media in New Zealand and investment analysts continue to closely watch the performance of sterling in general and its relationship with the New Zealand dollar in particular.

Traditionally, New Zealand was an exporter of primary commodities – agricultural produce and natural resources – to Britain, which in return exported finished goods such as cars to New Zealand. That relationship is long gone, but strong and influential economic links remain.

Britain is one of the largest external investors in New Zealand, as, separately, are UK territories the British Virgin Islands and the Cayman Islands. Financial commitments such as these, or any interruption to them, will impact the pound/dollar exchange rate.

The UK remains the fifth biggest destination for New Zealand exports, behind, in descending order, Australia, China, the United States and Japan. These trade flows are key to understanding the pound/dollar relationship.

British political events have a big influence on the New Zealand currency market with regard to the pound/dollar rate. To take two examples. Firstly, the outlining of the British Government’s industrial strategy in January 2017 saw sterling rise against the New Zealand dollar. Then in the following month, the news that the Scottish government was considering an independence vote weakened the pound against the dollar.

Interest rates. The UK is poised rather awkwardly between the US, which is tightening interest rates, and the Eurozone and Japan, which are pursuing zero interest-rate policies. In spring 2017, New Zealand’s official rate, at 1.75 per cent, was considerably higher than that in the UK, 0.25 per cent. All things being equal, New Zealand assets ought to be more attractive to investors, thus strengthening the dollar.

1. You can make the trade in the traditional way by buying or selling the currency in question, perhaps through your bank or through a trading account at a financial institution. This is straightforward and easy to keep tabs on. But it can be costly and time-consuming.

2. An alternative would be to use futures and options, derivative products that let you trade on the currencies involved without having to buy them. But futures trading can expose you to losing more than your original stake if your trade goes wrong. With options, you can just walk away, but you pay an up-front charge for the privilege of being able to do so.

3. Contracts for difference (CFDs). These have become the most popular way to trade on financial markets of all kinds. A CFD is a contract between a trader and a broker to pay each other the difference in the price of an asset from the day the contract is signed to the day it is terminated. They are leveraged products, meaning you can gain exposure by investing only a percentage of the full value of the trade you want. Whilst this gives opportunity for greater profit, you risk losing more than your deposit if the market moves against you. A second risk is that rapid price changes can cause your account balance to change quickly. If you do not have enough funds in your account to cover these situations, there is a risk your position may be closed automatically when your balance falls below a certain level, known as the close-out level. Stop-orders can limit risk but, in fast moving markets, prices might rise above or fall below the desired level before a sale can be executed. This may increase losses.

These are two currencies issued by countries with a shared heritage – indeed, a shared head of state – and prosperous, modern economies. There is never likely to be a liquidity shortage in trading them. But the relationship between the two currencies needs to be fully understood if trading is likely to prove successful.