3 Oct 2014

Dairy prices may hit rate hike timing

8:31 am on 3 October 2014

Economists are ratcheting back their expectations of when interest rates are likely to resume rising as dairy prices continue their downward trajectory.

dairy farming

Dairy is New Zealand's biggest export earner. Photo: Photo NZ

They now expect Fonterra will have to lower its forecast milk payout for a third time - Westpac estimates a payout of $4.80 a kilo of milk solids compared with the diary giant's $5.30 forecast.

That would suck about six billion dollars out of the economy compared with the previous season's $8.40 a kilo payout, shaving about 2.5 percentage points off economic growth.

The economy grew 3.5 percent in the year ended June.

Westpac was already expecting the Reserve Bank to hold off raising its official cash rate again until at least June next year.

ANZ Bank Market Strategist Carrick Lucas said his bank was now revisiting its expectations of another rate hike in March next year, with a view to pushing it out further.

While the continuing fall in dairy prices had taken analysts by surprise, many argued the New Zealand economy was strong enough to weather the storm.

Dairy was the country's biggest export earner and senior a cut in dairy returns means a cut in spending by farmers, FX strategist at the ANZ Bank Sam Tuck said.

"Everyone who relies on the dairy sector as a source of income or provides services to the dairy sector is going to be affected by that.

"We'd expect that to result in a decline in general business activity."

He said that was also expected to keep downward pressure on the New Zealand dollar.

"The dollar acts as a vital shock absorber for the economy and when prices are lowered you would expect the dollar to go lower in sympathy with the commodity prices.

"Now, obviously dairy isn't the only commodity but it is the major commodity that we produce, so you would expect the New Zealand dollar to decline."

Treasury Rankin Currency Analyst Derek Rankin argued that it was actually high interest rates that were having a bigger impact on the dollar and the overall economy.

He said while dairy prices influenced the dollar, they could not be relied on to do so.

"They are a moving feast, they go up they go down.

"So really I think the market is trying to get a fix on whether or not these dairy prices are going to stay down permanently or whether they will actually start to bounce back."

Mr Rankin also said overall the economy was riding high.

"The economy is in a great place and according to the latest budget we're going to have fiscal surpluses and all around the world people are talking about greater Government debt."

The Reserve Bank had said that the New Zealand dollar was unjustified and unsustainable at its current levels and the pressure from falling dairy prices was expected to see it fall further.

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