Dairy price fall hits NZ dollar

Falling milk prices continue to weigh on the commodity price index, but they're also chipping away at the strong New Zealand dollar.

Dairy prices dropped 4.2 per cent at Fonterra's latest GlobalDairyTrade auction yesterday, with a glut of supply on the market.

The four-month slump has seen the trade-weighted price index drop 26 per cent since the highs reached in February.

ASB economists said they could not read too much into one auction's results, but there was a risk that dairy prices could stabilise at a lower-than-expected level.

While it was "premature" to adjust their forecast farm-gate return of $7 per kilogram of milk solids next season, they have officially put it under review.

The New Zealand dollar dipped sharply after the auction, touching on a new three-month low overnight then falling further to US84.10 cents at 5pm yesterday.

A falling dollar is good news for primary producers, who have seen commodity prices drop 6 per cent year-on-year in New Zealand dollar terms.

ANZ's Commodity Price Index slipped 2.2 per cent in May, and has now fallen three months in a row.

Dairy led the decline with a 4.5 per cent drop, while forestry was also under pressure with growing Chinese inventories weighing on log prices.

Westpac senior economist Anne Boniface said while dairy grabbed the headlines, the likes of lamb and beef prices had been holding up well.

A total of seven commodity prices recorded a lift in May, led by a 5 per cent increase in wool prices.

A new season's export crop pushed fruit prices up, and seafood and sawn timber climbed modestly to recent highs.

While declining dairy prices means less money in farmers' pockets, it could bring some relief to mortgage holders awaiting higher interest rates.

Boniface said the drop could delay the Reserve Bank's series of scheduled increases to the Official Cash Rate, currently at 3 per cent.

"While, like us, the [Reserve] Bank has long been expecting dairy prices to soften this year, they may have been surprised by the extent of recent falls which could, on its own, make it less inclined to raise the OCR," Boniface said.

Reserve Bank governor Graeme Wheeler had been widely expected to raise the OCR to 3.25 per cent next week but ASB has described the next review as "event dependent".

A 25 basis point rise in mortgage rates would cost about an extra $11 a week for a household with a $300,000 mortgage on a 20-year term.