The rising Kiwi dollar is depressing already low dairy prices in local currency terms and adding to the pressure on the Reserve Bank to cut the OCR. With special feature audio.
Fonterra’s current milk payout forecast is looking increasingly in doubt after another poor auction result last week and as the New Zealand dollar continues to rise.
Fonterra is forecasting a $4.25 a kilo of milk solids payout but Mark Lister, head of wealth research at Craigs Investment Partners, says something closer to last season’s $3.90 payout is looking more likely.
Dairy farmers on average need a payout of about $5.20 a kilogram of milk solids to break even.
That as well as other developments, such as the Bank of England’s expected move to cut interest rates this week, is adding to the pressure on the New Zealand central bank to cut the official cash rate.
As for the pressures against an OCR cut, the Federal Reserve in the US isn’t one, despite stronger than expected jobs figures on Friday, Mr Lister says.
The US economy added 287,000 jobs last month, much stronger than the 180,000 figures economists had forecast.
“The general thinking is that the Fed is on the sidelines for the foreseeable future,” he says.
Fonterra’s payout forecast “is looking a little optimistic.”
The key whole milk price fell 1.6% in US dollar terms at last week’s auction and “one can assume that, with the recent strength in the currency, the New Zealand dollar price has drifted even lower still,” he says.
The New Zealand dollar rose 1.85% against the US dollar last week to 73.03USc, taking the gain so far this year to just shy of 7%.
One reason for the currency’s strong rise last week was the Reserve Bank deputy governor Grant Spencer’s failure to announce further loan-to-valuation restrictions on bank mortgage lending which the market had been expecting.
Concern about the impact on financial stability of soaring house prices is one reason the Reserve Bank may decide not to cut the OCR.
The flying kiwi
Since the start of this year, the Kiwi is up more than 3% against the Australian dollar – at 96.5Ac, that has revived talk of parity again – up nearly 22% against the British pound and up more than 5% against the euro.
Mr Lister says if the Bank of England cuts rates as expected, and the market has priced in a 74% chance that it will, sterling is likely to rise even further against the New Zealand dollar from its current level of just over 56 pence, just a little below its record.
“It’s just another factor that the Reserve Bank will be watching because that currency is getting worryingly high,” he says.
Ahead of the English central bank’s meeting on Thursday, the New Zealand central bank’s assistant governor and head of economics, John McDermott, is due to give a speech on Wednesday on how the Reserve Bank goes about making OCR decisions.
This speech “will certainly be closely watched,” even though it could just be about process.
“With the currency where it is, that’s a strong factor that suggests they should cut.”
But with market pricing currently indicating a 50/50 chance of a rate cut in August and economists unable to agree on what the Reserve Bank will decide, “there’s every chance that he will give some hint that might cause the market to think one way or the other,” Mr Lister says.
On Friday, ANZ Bank’s economists changed their view and said the central bank won’t raise the OCR in August because the economy is strong and the housing market strength is spilling over into the general economy.
But Bank of New Zealand’s economists, who have been arguing against OCR cuts, said the market’s reaction to Mr Spencer’s speech makes an OCR cut in August more likely.
“We think the financial market reaction to [Mr Spencer’s speech] is rational, to be expected but unwise,” BNZ said.
Follow NBR on Facebook, Twitter, LinkedIn and Instagram for the latest news and free on-demand audio from NBR Radio.
