Federated Farmers: Year of highs and lows in beef and dairy

It has been a trying year for beef and dairy.

It's safe to say that the economic backdrop for the farming sector is ending the year markedly different from how it started. There's been a dramatic shift in relative fortunes, as dairy prices have swung from record highs to alarming lows, while beef prices have soared. Concerns about interest rates rising to keep inflation in check have turned into questions about how long interest rates will be able to remain low. And there have been world trade developments that could become even more significant next year.

The big price shifts in two of our major export products are a story of supply and demand. Last year, world dairy prices had surged higher on fears of a global supply shortage, driven firstly by a short, severe drought in New Zealand, then concerns about drought in China. Both prices and volumes of dairy products sold to China exploded last year as Chinese buyers stockpiled product.

In hindsight, those concerns were overdone. Milk production in New Zealand recovered strongly, while the other major milk producers also began to lift production in response to falling feed prices and the very high milk prices. At the same time, demand from China has softened this year.

The result is that Chinese buyers appear to have been left with a sizeable overhang of inventory. Only once this has been run down will demand, and prices, return to more normal levels. We expect that to happen early next year -- but if it takes longer, our already-low forecast of a $4.80/kg payout from Fonterra this season could fall even lower.

Beef prices, on the other hand, are more a story of the United States market. Drought and ongoing herd reductions led to a severe supply shortfall in the US over the peak summer period, sending prices rocketing higher for what product was available. Subsequently, Australian and New Zealand imports helped fill the gap, and prices have started to come off their peaks. However, we expect they will stay elevated for some time.

Turning to local conditions, the New Zealand economy has continued to grow at an above-trend pace this year, making us one of the strongest performers in the developed world. By the start of this year, there were signs that continued strong growth was starting to put pressure on prices, and in March the Reserve Bank raised interest rates to keep inflation in check. But that inflation pressure soon petered out: annual inflation is likely to end the year at 1 per cent or even less. It's not that economic growth has fallen short; rather, it appears that the economy's capacity to grow without inflation has been greater than thought. Further interest rate hikes are now expected to be delayed until late next year at the earliest.

Towards the end of this year, another loose theme emerged. Australia concluded a free trade agreement (FTA) with China after almost a decade of negotiations, while New Zealand signed an FTA with South Korea, our fifth-largest export market. In 2008, New Zealand became the first developed country to sign an FTA with China, putting us in a relatively privileged position. The Australia-China FTA means New Zealand loses some of its uniqueness, and in that sense it's a modest negative for us.

However, this underscores that in a world where trade protectionism is the norm, it's vitally important to be on the 'inside' of any trade agreement.

With that in mind, it's worth watching the progress of the Trans-Pacific Partnership Agreement, which may be concluded next year.