KEY POINTS:
The bumper payout Fonterra has forecast for next season will give the economy a surge of adrenaline, but at a time when it needs to be taking things easy from the standpoint of inflation and interest rates.
Bank of New Zealand economist Craig Ebert estimates the increase in
the dairy payout from $4.35 a kilogram of milk solids this season to $5.53 next season would inject an extra $1.75 billion into farmers' pockets.
"It's a very big deal - bigger than the Working for Families fiscal stimulus under full steam," he said.
"Sure there's a timing issue, in that farmers won't get the cash until next season. But the square-up for the season just finishing will be meaningful up front. And the $5.53 payout will be paid out in quarterly instalments through next season, not as a lump sum at the end."
It was unfortunate it would occur when the economy needed to cool its heels for a while to relieve inflation pressure, Ebert said.
Over the past six months the terms of trade - a measure of the relative prices of the kinds of things New Zealand exports and the kinds of things it imports - had improved by about 10 per cent, he said.
That has been mainly driven by a surge in the world price of New Zealand's export commodities, 17 per cent over the past six months, principally for dairy products.
Last month alone ANZ's commodity price index rose 4.8 per cent in world price terms, including an 11.8 per cent rise in dairy prices. But even without dairy, which makes up 30 per cent of the commodity basket, the index would have risen 1.2 per cent last month.
The problem for borrowers is that the Reserve Bank's last monetary policy statement (MPS) in March assumed very little change in the terms of trade.
"It looks to have completely missed the recent boom in its base calculations," Ebert said. So the June MPS would have to include a much stronger terms-of-trade picture, more than would be offset by the stronger-than-expected exchange rate.
This increased the odds of another rise in the official cash rate, he said.
Westpac economists expect the dairy price boom to endure, underpinned by growing demand. Global milk consumption is rising by about 3 per cent a year.
Westpac chief economist Brendan O'Donovan said reduced supply from a drought-stricken Australia had contributed to the price rise and experience suggested some of that cut in production would be permanent.
In the US, the world's largest exporter of milk powder, grain feed costs had risen sharply because of new demand for corn for ethanol production - so sharply that increasing milk production was not profitable even at current dairy prices.
The competing demand from the biofuels industry was expected to persist, O'Donovan said.
Local returns depend not only on world prices but the exchange rate, which is at historically very high levels, especially against the US dollar.
Fonterra has indicated its projected $5.53 payout is based on an average currency conversion of US71c to the kiwi dollar.
O'Donovan said the tendency of the currency to rise and fall with commodity prices was a desirable buffer.
"When commodity prices drop an exchange rate fall softens the blow for exporters," he said.
"When commodity prices lift, an exchange rate rise diffuses the benefit throughout the economy by making imports cheaper."