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Home / Business / Economy / Official Cash Rate

Soaring dairy prices trigger fresh rate rise fears

Brian Fallow
By Brian Fallow
Columnist·
5 Jul, 2007 05:00 PM3 mins to read

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KEY POINTS:

World prices for dairy products soared 13 per cent last month, raising hopes of an even higher Fonterra payout but also fears of another interest rate rise from the Reserve Bank.

The ANZ world commodity price index increased 6.1 per cent in June to be 29.6 per cent
higher than a year ago. The increase was driven by dairy prices which make up a third of the index and which have almost doubled since June last year.

The rise outstripped the currency's surge to new post-float highs, so that even in New Zealand dollar terms the basket of export commodities was worth 2.5 per cent more than in May and 7.2 per cent more than a year ago.

Last month the Reserve Bank cited Fonterra's forecast payout of $5.53 a kg of milksolids as a reason for raising the official cash rate to 8 per cent. But now even that price was looking light, said ANZ National Bank chief economist Cameron Bagrie. "We could be looking at something above $6."

The Reserve Bank's June statement included a scenario for even higher interest rates, based on higher dairy prices and additional capacity constraints in the economy.

"We have now had the first leg of the quinella," Bagrie said. "And we will get a insight into capacity constraints from next week's quarterly survey of business opinion."

But Bagrie hoped Governor Alan Bollard would not tighten again.

The dollar has risen 5 per cent against the US dollar since the last interest rate move, despite central bank intervention.

"Dairy is only 20 per cent of our exports and there is real pain for the other 80 per cent with the dollar at [US]78c," he said.

Excluding dairy products, commodity prices rose 0.8 per cent last month, making 4.9 per cent for the year.

Even before the latest rise in dairy prices the terms of trade - the ratio of export to import prices - were the most favourable they have been since 1974. But it would be wrong to conclude that alone justified a higher trend value of the New Zealand dollar, he said.

The country's deteriorating productivity performance threatened to erode the income boost from strong terms of trade.

Productivity growth in those parts of the economy where it can readily be measured - about two-thirds of the total - had declined from an average 2.5 per cent a year in the 1990s to 1.1 per cent since 2001.

"We would need a terms of trade boost of about 6 per cent a year to offset that and merely to match economic performance over the 1990s," he said.

The annual Agricultural Outlook from the OECD and the United Nations' Food and Agriculture Organisation, released yesterday, sees the rise in world dairy prices as a symptom of broader structural changes.

Urbanisation and higher incomes in developing countries have shifted diets towards higher consumption of dairy products.

At the same time technological advances have fostered more value-added processing of dairy products including whole milk powder.

Commodity prices

* ANZ world index up 6.1 per cent in June.

* 29.6 per cent higher than a year ago.

* In New Zealand terms, the commodities are worth 7.2 per cent more than a year ago.

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