Westpac strategist says currency traders were ‘glued’ to the results of the latest auction.
Falling dairy prices could weigh on the New Zealand dollar and help push the currency as low as US80c against the greenback by the end of this year, says an analyst.
Dairy prices plunged to the lowest level since October 2012 in the GlobalDairyTrade auction yesterday, with the GDT price index dropping 8.4 per cent, and the average winning price falling to US$3025 a tonne from US$3309 at the last auction.
The New Zealand dollar fell by almost 1c from US85.21c just before midnight on Tuesday to US84.23c by 1pm yesterday. It recovered some ground to be trading at US84.31c at 6pm.
Westpac senior market strategist Imre Speizer said the drop in dairy prices, a strengthening greenback and risk aversion among investors globally had sparked the kiwi's fall.
Currency traders had been "glued" to the results of the GDT auction, he said.
"I'd say this auction was probably the most widely followed since they began [in 2008]." Whole milk powder fell 11.5 per cent to US$2725 a tonne in the latest auction, while cheddar shed 10.2 per cent to US$3742 a tonne.
Falling dairy prices could contribute to a pull-back in the Reserve Bank's tightening cycle on interest rates, which would place further pressure on the New Zealand dollar.
Combined with a corresponding lift in the US dollar, the kiwi could fall to between US80c and US82c by the end of the year, Speizer said.
Economists have pointed to lacklustre demand from China, as well as stockpiling of dairy products that took place in the Chinese market earlier this year, as the major cause of the falling prices.
Hayley Moynihan, Rabobank's director of dairy research for New Zealand and Asia, said a bigger factor driving the decline had been a massive increase in supply.
While milk supply had fallen by around half a billion litres during the first half of 2013, it had increased by roughly seven billion litres in the same period of this year, Moynihan said. "It's a huge swing."
Moynihan said around 45 per cent of the increased supply had come from Europe, 20 per cent from New Zealand and the same proportion from the United States.
The increased supply was a response from producers looking to cash in on last year's record prices, as well as a lack of adverse weather conditions such a droughts around the world, she said, adding that prices were unlikely to improve before the end of the year.
"In the absence of a market shock I think this price trough is going to persist."
Westpac senior economist Anne Boniface said the falling prices created a "clear risk" that Fonterra's 2014/15 payout could fall below the bank's current forecast of $6 per kg of milk solids.
The dairy co-operative is also forecasting a $6 per kg payout, which it reduced from a forecast of $7 last week. "We'd prefer to see another auction before ... cementing in a new forecast," Boniface said. "There is still a lot of water to go under the bridge before the end of the 2014/15 season and as we've seen, commodity prices can be volatile in both directions." But she said the "downside risks" to the forecast were clear.
"The further dairy prices fall, the more difficult it is for prices to stage a rebound of the magnitude we have factored into our forecasts, particularly in the absence of usual catalysts such as drought, rocketing grain prices or some other disruption to the outlook for supply," Boniface said.
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Last week's reduction in the forecast payout represented a total drop in payments to farmers of nearly $1.6 billion from Fonterra's earlier forecast and a cut in farmers' collective income of roughly $4.3 billion compared with last season's record pay-out, according to Westpac.
Federated Farmers dairy chairman Andrew Hoggard said he hoped Fonterra had factored "some more drops" in the GDT auctions into its revised forecast and the co-operative would not need to reduce it further.
"It just reinforces ... that it's going to be a tight year," Hoggard said.
What's hitting prices?
• A drop in Chinese demand, combined with stockpiling of dairy products in China earlier this year.
• A big increase in supply this year in response to previously high prices, particularly from major dairy producers such as New Zealand, Europe and the United States.
• A lack of adverse weather, such as droughts, globally.