Past the sweet spot

Last week’s labour market data raised fresh doubts about the economy’s capacity to accommodate all the growth that is going on without generating inflation pressure, supporting the case for raising the OCR further over the next few years. But with dairy prices continuing to fall the Reserve Bank is unlikely to be nudged off its current ‘period of assessment’ for a while yet.

Dairy prices continued to tumble in Fonterra’s latest auction, with whole milk powder prices falling to their lowest level since late 2012.

As we’ve noted in recent weeks, the most recent bout of weakness can no longer be pinned on recovering global supplies, and instead seems to be due to weaker Chinese demand – more cautious consumers, and a resulting build-up of milk-powder stocks in Chinese warehouses.

The latest fall in auction prices creates a clear risk that the farm gate milk price for the current season will come out below our current forecast, which sits at $6. We will await another auction result before formally cementing in a new forecast – there is still a lot of water to go under the bridge before the end of the season, and we still expect a solid rebound in dairy prices by the end of the year as Chinese wholesalers work off their stocks and demand starts to recover. But clearly, the further dairy prices keep falling, the harder it will be for prices to stage a rebound of the size required to meet our $6 forecast – at least in the absence of drought, rocketing grain prices or some other disruption to dairy supplies. And those don’t look likely - US grain prices are falling, and earlier warnings of a severe El Niño event have been downgraded.