Christmas cheer required

Falling milk prices are being matched by falling oil prices.

Fonterra's slashed payout for its dairy farmer shareholders is just the sort of Christmas present nobody wants.

It's not just the Fonterra shareholders who will bear the brunt of yesterday's announcement but the economy as a whole.

Fonterra has said it will work with dairy farmers to ease the pain which will certainly be felt strongly by those with highly geared balance sheets.

But the issue is wider than the farmers' plight. Finance Minister Bill English and Reserve Bank governor Graeme Wheeler will also be factoring the Fonterra move into their own equations.

Dairy farmers account for $32 billion worth of debt. The Reserve Bank says close to 70 per cent of that debt is on floating mortgage rates, which leaves farmers especially exposed to any changes to the OCR.

This will have weighed heavily on the central bank governor's mind as he prepared to announce the next OCR level at 9am today.

As analyst Sean Keane notes: "The larger-than-expected decline in the dairy payout will certainly impact economic activity directly, while the falling price of oil will impact on the underlying inflation rate indirectly via secondary pricing effects. Ideally, the RBNZ will announce that these influences are broadly offsetting, and that it is comfortable with interest rate policy settings and the near-term outlook.

"If that is the case then the RBNZ should formally move to a neutral policy stance, though if it does so it will be carefully worded."

A neutral interest rate stance - or a cut - would be good news for other parts of the broader economy, giving a fillip to business activity and household consumption.

It will also take pressure off farmers.

It was expected that Fonterra would have to downgrade the $5.30/kgMS payout earlier forecast to a figure that better reflected the realities of global dairy prices. But a further 60 cent slash to $4.70/kgMS was at the lower end of even the most pessimistic of commentators.

Compared with last season's record farmgate milk payout of $8.40/kgMS, the $3.70 drop will shave $6.6 billion from dairy income and 2.7 per cent of national GDP, say Westpac's economists.

During that period, prices for whole milk powder have plummeted from record highs to the lowest levels since August 2009 on the Global Dairy auction platform.

Con Williams, rural economist at ANZ, weighed in that a payout in the sub $5/kgMS range would be manageable for the dairy sector this year, but would have an adverse impact on cash flows for the 2015/16 season.

He warned that continued softness in global prices could drive significant change to cost structures in an effort to remain competitive.

Westpac has predicted the farmgate milk price to rebound to $6.20 for the 2015/16 season, but that comes with the caveat that milk prices rise rapidlyover 2015.

At last year's National Fieldays, Dairy NZ chief executive Tim Mackle said analysis showed a sizeable proportion of farmers needed to earn at least $6 per kilogram just to cover their farming essentials - primary expenses and servicing interest payments. That's before any personal drawings or mortgage payments are taken into the equation.

Dairy farmers will continue to hold out hope for an improved dividend share to bolster milk prices after significant international investment in recent years, but Fonterra has thus far left the dividend range unchanged at 25-35 cents per share.

There could be a glimmer of hope, with a revised dividend to be announced in April to coincide with the release of Fonterra's interim financial results.

Ian Brown, chairman of Fonterra's Shareholders' Council, said: "Fonterra has had a significant focus on implementing the strategy over the past couple of years and it is important, especially in a season where the milk price is down, that farmers receive the full benefit for their investment in the integrated supply chain that their co-op provides."