By Roger J Kerr
Credit rating agency Standard & Poor’s recent warning that New Zealand’s sovereign credit rating could be under threat from global warming is a timely reminder of just how dependent the NZ economy is on agriculture production.
More frequent extreme weather events (e.g. drought) are a much higher risk for our economy than most others as we remain heavily dependent on agriculture exports for our income and wealth.
Mitigating the risk to some extent is increased investment in irrigation schemes to harness water resources and reduce climatic risk and this is well recognised by the Government and industry groups.
Placating the environmental concerns stemming from more intensive agriculture production from more irrigation schemes is one of the largest economic issues New Zealand faces over coming years.
My view, at this point in time, is that the financial markets and many economic forecasters are naively, conveniently or deliberately ignoring the importance of primary industry production and prices in terms of our current economic outlook.
Previously high log prices are now falling back as Chinese demand cools and wholemilk powder (WMP) prices are likely to fall again at this Tuesday night’s GDT/Fonterra auction on top of the 22% plummet in prices over recent months.
It was not a great surprise to me that retail sales in the Waikato contracted in the latest figures released.
A large reduction in the 2014/2105 dairy season’s milksolids payout forecast from the record high of $8.65 this season is clearly jolting provincial New Zealand into hasty revisions of spending plans.
Fonterra will announce their new milksolids payout forecast towards the end of this month. The RBNZ have been on the ball in highlighting the growing divergence between our economic fundamentals (i.e. lower WMP and Terms of Trade Index) and the high Kiwi dollar value.
A continuation of the price divergence is very negative for our GDP growth; alas most seem oblivious of the resultant economic risk.
What does all this mean for future interest rate direction?
GDP growth forecast have to be revised downwards as rural incomes reduce, in turn resulting in an adjustment down in the CPI inflation forecast over the next 12 months.
The lower inflation track must force the RBNZ to lower the extent of OCR increases this year and next.
The inflation risks from the housing market are abating from the LVR measures and rising mortgage interest rates.
Increasing capacity utilisation in the manufacturing sector does however still point to rising inflation.
However, the now much higher NZD/AUD cross-rate is hitting manufacturing exporters to Australia hard as previous currency hedging runs out and many are reducing export volumes as it is difficult to make a profit at 0.93 unless they can secure price increases.
Some speed wobbles are already emerging for the “rock-star” economy.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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