The dairy industry is a critical component of New Zealand’s economy. According to the Dairy Companies Association of New Zealand, dairy is the country’s largest export earner, accounting for 13.7 billion New Zealand dollars (or $US9.6 billion in today’s exchange rates) and more than 29% of exports.
A sharp drop in milk prices caused the Reserve Bank of New Zealand to unexpectedly cut its benchmark interest rate 25 basis points to 3.25% at its June 10 policy meeting. The surprise cut marked an end to the rate hike cycle that began in March of 2014, which produced four consecutive rate hikes and raised the RBNZ’s key interest rate 100 basis points to 3.50%.
According to UBS:
Notably, the RBNZ’s revised economic outlook has weakened since the March Monetary Policy Statement, mostly due to deteriorating terms of trade; the recent dairy price rally has reversed and the likelihood has increased that prices will now stay depressed. According to the RBNZ forecast, Fonterra’s current milk payout guidance of NZD 5.25 per kilogram of milk solids for the 2015/16 season is now unlikely.
Here’s a look at milk prices in New Zealand:
Here’s the Reserve Bank of New Zealand’s take:
With the fall in commodity prices and the expected weakening in demand, the exchange rate has declined from its recent peak in April, but remains overvalued. A further significant downward adjustment is justified. In light of the forecast deterioration in the current account balance, such an exchange rate adjustment is needed to put New Zealand’s net external position on a more sustainable path.
The RBNZ continued:
We expect further easing may be appropriate. This will depend on the emerging data.
The New Zealand dollar tumbled to a fresh five-year low on the news.