Dairy doldrums keep Reserve Bank nervous

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A slow recovery in global milk prices weighing on the local dairy sector is making the Reserve Bank nervous.

The prospect of another sub-standard season is threatening New Zealand's national income.

Global dairy prices halved last year as Chinese buyers scaled back their activity after stockpiling in 2013, and milk processors have pared back their expected payments to farmer suppliers as a result.

The Reserve Bank cited the weak outlook in today's monetary policy statement as threatening to keep a lid on already low inflation, as it drove down the terms of trade more than previously forecast.

The central bank expects a more severe deterioration in the terms of trade - falling 8.4% in the March 2016 year, before rising just 0.1% the following year. In its March forecast, the bank expected terms of trade to be 3% lower in 2016, before gaining 1.4% in 2017. Terms of trade measure the value of imports that can be purchased by a set amount of exports.

"Relative to last season's record payout, farmers' incomes in the 2014/15 season are expected to be around $7 billion lower, representing a fall of about 3% of nominal GDP," the bank says. "If the dairy payout is low in the 2015/16 season as well, farmers' spending could fall sharply. Moreover, there is a risk that lower cashflows will limit the ability of farmers to smooth their expenditure."

Governor Graeme Wheeler last month flagged a weak dairy sector as one of three key risks to the nation's financial stability, saying about a quarter of farmers were operating in negative cashflow this season. He says they are relying on short-term loans to cover their working capital. If prices didn't recover, that would put stress on parts of the sector, which in turn could taint banks' loan books.

The Reserve Bank today says dairy production by other major exporters such as Europe and the US remains high, which continues to undermine the recovery in process. Prices are projected to slowly rise back to a more sustainable level in the next couple of years.

(BusinessDesk)

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