Brakes on rate hikes after 'double-whammy'

00:21, Jul 16 2014

Official interest rate increases could be put on hold by a ''double-whammy'' drop in dairy prices and softer than expected inflation figures, economists say.

Dairy prices fell another 8.9 per cent in Fonterra's latest GlobalDairyTrade auction overnight and were down by a third since January.

Forecast farm-gate returns have been slashed as low as $6 a kilogram of milksolids for next season, meaning farmers will take a potential pay cut of $3.5 billion.

At the same time, annual inflation has come in lower than expected at 1.6 per cent for the year to June, barely changed from the March year.

The Reserve Bank was expected to increase the official cash rate (OCR) next week to hit 3.5 per cent.

But Westpac senior economist Anne Boniface said: ''After today's data double-whammy, we think markets should pause for thought.


''A July OCR-hike may not be quite such a sure thing as previously thought.''

Boniface said the 13 per cent fall in dairy prices over the last two auctions ''has come not only as a surprise to us, but probably the Reserve Bank as well''.

''It will be one of the key pieces of news being digested by the central bank ahead of next week's OCR review,'' she said.

The effect has been compounded by inaction in currency markets.

The New Zealand dollar was little changed after the poor auction results, although the soft CPI figures have pushed it down almost 1c from its overnight high.

However, it is still trading at historically lofty levels above US87c.

Bank of New Zealand head of research Stephen Toplis said for all intents and purposes, the currency had completely ignored a strong downtrend in commodity prices in recent months.

At some stage either the currency would catch up, or dairy revenues would be ''extremely adversely impacted'', he said.

''In conjunction with that, you are probably going to see a lower interest rate track than anyone is currently forecasting as a consequence.

''The problem is, you don't know which will come first.''

The Reserve Bank was facing an ''awful conundrum'', torn between a strong domestic economy and negative pressures from commodities and the currency. As markets had already priced in next week's expected rise, interest rates would actually fall if the central bank did not deliver, he said.

The expected resumption of rate rise in September and October would be called into question if the currency did not ease, Toplis said.

ASB rural economist Nathan Penny also said the weakening dairy market would have widespread implications for the broader economy.

"It's going to reduce farmer incomes, and depending on where this ends up - it's hard to tell where this is going - it could put downward pressure on interest rates," he said.

Dairy prices are now the lowest since the end of 2012, according to the Global Dairy Trade exchange.

The dairy sector is a huge part of the New Zealand economy, with a DairyNZ report earlier this week saying it contributed $14.32b last year.