Weak dairy prices may force Treasury to pull back economic forecasts

Treasury may have to pull back its forecasts for New Zealand's economy as prices for whole milk powder, the nation's key commodity export, lag behind expectations.

In its half year economic and fiscal update published in December, Treasury said its forecasts were based on a 25 percent recovery in dairy prices by the start of 2016, although it said the risks were tilted towards a slower recovery. In its monthly economic indicators published this week, Treasury said prices "so far are in line" with its December forecast, "but further increases are needed to achieve the recovery in dairy export prices that we forecast in the second half of this year." It will update its latest economic forecasts as part of the budget on May 21.

Prices for whole milk powder dropped an average 1.8 percent to US$2,386 a tonne in this week's GlobalDairyTrade auction, extending its decline over the past five auctions to 27 percent. Auckland-based Fonterra Cooperative Group, the world's largest dairy exporter, last week cut its forecast payout to farmers for the 2014/15 season to $4.50 per kilogram of milk solids from $4.70/kgMS after whole milk powder prices failed to strengthen to US$3,500/t as expected, and analysts have pulled back their expectations for next season's payout.

July whole milk powder futures on the NZX last changed hands at US$2,420/t, while December futures last traded at US$2,700/t.

Treasury "wouldn't have factored in their equations a lower-for-longer price," said Mike McIntyre, head of derivatives at First NZ Capital. "At this stage, prices have been lower internationally than what the whole market expected and unless we have a dramatic recovery in the next couple of months then there may have to be some sort of revision."

Whole milk powder prices spiked higher earlier this year on concern drought conditions may crimp milk production, but they quickly fell away again when that turned out not to be the case. Fonterra now expects production this season to lift 1.5 percent from last season, from a previous forecast that it could fall 3.3 percent.

Dairy products are New Zealand's largest commodity export group and the dairy sector generates more than 7 percent of the country's gross domestic product. The Bank of New Zealand estimates Fonterra's forecast for the current season is below the cost of production for many farmers and expects dairy sector revenue for the current season will shrink by about $6.7 billion.

Finance Minister Bill English warned in his pre-budget speech this month that achieving a budget surplus next year is becoming more difficult. He said the budget would forecast a slightly bigger deficit than the $570 million previously expected in the year through June, and a smaller surplus for the 2015/16 year.

(BusinessDesk)