European politicians and officials are still fighting to contain the spread of the crisis amid bulging sovereign debt levels and increased scepticism about the ability of the fragile European banking system to cope with defaults. With no clear resolution in sight, the risks to the global financial system the crisis have generated remain a concern for policy makers, politicians and investors.
In such a volatile and uncertain environment, caution is the prevailing sentiment in financial markets. For a while at least, uncertainty, volatility and the small probability of a catastrophic outcome in Europe are keeping the RBNZ firmly on the sidelines. A position it can afford to maintain for some time yet - particularly given there is little sign of domestic inflation pressure. We expect the bank to leave the OCR at the historic low of 2.5 per cent until September, when it is likely to start raising rates as reconstruction activity (and activity elsewhere) soaks up spare capacity in the economy. Despite widespread expectations the OCR will remain on hold for some time, retail interest rates in New Zealand could rise sooner because of the higher funding costs banks are facing in offshore markets.
International investors are being very cautious about who they are lending to, when they are lending and are charging a much higher price.
The outlook for the NZD is ultimately linked to the outlook for commodity prices.
In this regard, with global growth expected to slow significantly in 2012 (a combination of a European recession, and slower growth across much of Asia, including China) we expect further downward pressure on export commodity prices during the coming months (although even at their trough, prices are expected to remain well above average levels of the last decade). This will put downward pressure on the NZD in the near term, which in turn should help buffer farm gate prices. Over a longer horizon, interest rates rising faster in New Zealand than elsewhere, and a recovery in global food prices should argue in favour of an appreciation in the NZD/USD.
The rural land market has demonstrated tentative signs of improvement of late. In recent months prices and sales volumes have been edging higher. The key outlier remains prices for horticulture land. The kiwifruit industry's ongoing battle with PSA has hit orchard prices hard, and prices are likely to remain under a cloud as the industry works to find a solution.
After falling sharply in the first half of the year, international dairy prices have broadly stabilised lately - a pretty impressive result given deteriorating global growth prospects and strong growth in domestic supply during the period.
We suspect the respite may prove temporary, with further increases in supply and slowing demand likely to put further modest downward pressure on dairy prices during the next few months before a recovery in price later in the year.
Wool prices have begun to edge lower but remain at historically high levels. We expect prices to ease further during the coming months due to increased price competition from substitutes such as cotton and polyester, and tougher conditions in export markets. Globally, supplies remain tight and this should mean prices find support well above historical average levels.
Boosted by upgraded estimates of wheat production in Australia and Canada, the USDA now expects global wheat production to be six per cent higher in 2011-12. This would be a record.
Global corn production is also expected to reach a record high in 2011-12, up 5 per cent on the previous year. Plentiful supply, along with expectations of sluggish demand growth in key markets and slightly softer ethanol demand could see grain prices, already well below their early 2011 highs, head lower in the coming months.
The widespread drought, which has led to a jump in cattle slaughter numbers and declining stock numbers across the southeastern states of the US, has shown some signs of easing but its after-effects are likely to continue to feature in beef markets. Given the time taken for cattle to reach slaughter-ready weight from birth, supplies will be slow to rebound, providing support to prices during the coming year even among lacklustre consumer demand in key markets.