7 Mar 2013

Drought tipped to lead to widening of deficit

7:02 am on 7 March 2013

BNZ economist Doug Steel is picking the drought which is hitting dairy volumes will lead to a widening of the current account deficit by the end of the year.

Global dairy prices jumped by a tenth at Fonterra's bi-monthly auction on Wednesday, its fastest pace in nearly two years.

Fonterra says the average winning price rose 10% to $US4216 a metric tonne, with gains across the board, including an 18% increase for whole milk powder.

It was the sixth consecutive rise in prices, and the biggest since early June 2012.

Dairy prices, which peaked in October 2007, have gained about 18% so far this year.

Mr Steel said it's a classic case of demand outstripping supply and pushing up prices.

He said the increase in construction in many parts of the country, particularly in Auckland and Christchurch will lead to quite strong domestic growth, but the export sector is likely to struggle because of the drought conditions.

"That dichotomy between the domestic demand and exports is likely to widen the trade deficit and more generally the current account deficit.

''So at the moment the current account deficit is sitting just under 5% of GDP, we think it's going to be getting much closer to 6% of GDP by the end of 13 and maybe even 7% of GDP by 2014-15."

Mr Steel said that will attract the attention of international investors and maybe even international rating agencies down the track.

He said there is a risk that the markets get a bit jittery and if that happens then it's likely to lead to higher domestic interest rates or the kiwi (dollar) could come down.

But Mr Steel said that's not likely to happen until the end of the year or in 2014 and in the short term the kiwiis likely to be responding to the growth outlook in New Zealand relative to the rest of the world.