Dry run

The undertone of last week’s data was that the New Zealand economy remains robust but skewed towards domestic activity – and likely to be even more so over the first half of this year as the impact of another drought comes to bear. There was also further support for our view that the Reserve Bank will be able to hold its nerve through a period of very low inflation.

Dairy prices rose another 10% in the latest GlobalDairyTrade auction, including a 13.7% rise for whole milk powder, New Zealand’s biggest export product. Dairy prices have now recovered almost 30% of the fall that we saw over the course of last year. The market has clearly got the message: dry conditions will curtail New Zealand’s milk production over coming months, which in turn will have a significant impact on the volume of dairy products that are available for international trade.

As we’ve noted before, the previous drought in 2013 ended up being a net positive for industry-wide revenue, as the spike in world dairy prices far outstripped the fall in volumes. We’ve been reluctant to assume anything more than a revenue-neutral impact from this year’s drought, for a number of reasons – stronger growth in the global milk supply and concerns about the strength of demand in some major markets. But the last two auction results raise the risk in our minds that history could repeat after all.

To be clear, the drought in New Zealand isn’t the only factor in play at the moment. There are tentative signs that the growth in US and European milk production was flattening out by the end of 2014, a delayed response to the fall in prices. And the most recent trade figures (for December) showed that whole milk powder exports to China were back to something that could reasonably be considered trend, having been distinctly sub-par over most of 2014.