Milk price volatility and the domestic economy

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Milk price volatility and the domestic economy.

You could be forgiven for getting confused over the recent volatility in the milk price and what it means for farmers and the domestic economy. The volatility has been abnormally large, and the flow-on impacts are not always clear-cut.

Firstly, the volatility: From its peak the milk price (as measured by the Global Dairy Trade Index) fell by two-thirds from April 2013 until early August this year. This is a very significant fall and placed farmers' incomes under increased pressure. In the last couple of months the milk price has bounced strongly and is up 48% off its recent lows. This bounce is due to a forecast reduction in New Zealand farmers' milk production this year of over 5% and the further threat of a major drought in New Zealand this summer impacting milk supply.

The good news for farmers is that the bounce in dairy price has seen their forecast milk pay out from Fonterra for the 2015/16 season increase from an estimated $3.85/kg of milk solids to $4.60/kg, however it still remains below the industry break-even estimate of $5.30/kg, so farmers are still hurting.

Unless you are directly involved in farming, the volatility is unlikely to affect people on a day-to-day basis. Although, as a cornerstone industry to the New Zealand economy there is a "trickle down" impact from lower farmer spending, particularly in regional areas. The fall in the milk price has caused New Zealand to lose our "rock star economy" status bandied around by offshore commentators 18 months ago, when the New Zealand economy was forecast to grow at around 3.5%pa and the milk price was near a six year high.

The Reserve Bank of New Zealand is now forecasting the economy will grow at a more moderate 2.0% in the next year, but this should be seen in the context of our long-term average growth rate of around 2.5%. Although the 2.0% estimated growth rate is below long-term trend, it is still strong enough for our corporates to continue to prosper and reward shareholders with increasing profits and dividends, necessary for positive shareholder returns.


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