Dairy upturn to assist in New Zealand’s economic recovery

One of the key drivers of the ups and downs in New Zealand’s economy is not just the sometimes highly emotive toing and froing of the housing market, but the more fundamental cyclical changes in primary export prices. As a rule, when our export prices rise the economy’s growth rate accelerates from out of the regions into the cities. Wages growth picks up, retail sales strengthen, housing eventually benefits, migration can improve, and after a while interest rates go up along with the exchange rate – which has probably already risen anyway. 

As it turns out, with the outlook for world growth lifting sharply in recent weeks, and with China displaying high demand for New Zealand’s “soft” commodities (as opposed to Australia’s “hard” commodities like coal), some of our export prices have lifted firmly. 

The important one is dairying. At the most recent fortnightly Global Dairy Trade auction the average prices measure jumped by 15% after rising 23% cumulatively from previous auctions starting in November. Prices are now 39% up from a year earlier and at their highest level in seven years.

As a result, Fonterra have lifted their forecast for this season’s payout, and this will inject many hundreds of millions of dollars into the New Zealand economy. But here is where it gets interesting. The higher payouts don’t start right away for dairy farmers. They rise with a lag. Just as the farmers will be receiving far better cash flows, so too will tourism sector operators from early next year probably be seeing a potentially strong lift in cash receipts.

At the same time, we are likely to see net migration inflows lift anew, especially as Kiwis still overseas wanting to get back come flooding in. Plus, there will be growth-supporting rises in house construction, local and central government infrastructure spending, and stronger business capital spending generally which will likely be assisted by banks becoming more willing to lend to businesses.

But along with these new sources of growth there will be some new restraints. One is highly likely to be a higher NZD pushing towards US 80 cents – because that is what tends to happen when our export prices rise. 

In addition, very soon we are likely to see bank fixed mortgage interest rates rising in response to the now well-known rises in wholesale medium- to long-term funding costs around the world – in spite of central bank promises to keep floating rate costs low.

Very few banks outside of maybe the United States fund their fixed rate lending with floating rate borrowing. This process of “riding the curve” can be very dangerous and is actively avoided by banks in New Zealand especially.

There will also be some restraint on NZ’s growth gains from Kiwis diverting their $10bn per annum worth of foreign travel spending back towards businesses offshore rather than retailers of spas and motorcycles in New Zealand.

There will also be some restraint from worsening shortages of labour along with shortages of readily developable land around all the country (except Auckland where the Unitary Plan makes intensification quite easy). 

Overall, while the improving prospects for growth probably won’t be enough to convince the Reserve Bank that it should raise its official cash rate from 0.25% this year, it could be a very different story for 2022. This is especially so because of one very important thing which many people probably still haven’t cottoned on to.

A year ago, central bankers made the explicit decision to target the risk of keeping interest rates too low for too long in order to guarantee economic recovery post-pandemic. They did this knowing they can easily catch up on fighting inflationary pressures when they appear by quickly raising interest rates. That is what lies in prospect for the period 2022-24 at varying speeds around the world. As that happens, we should expect some fairly high volatility in exchange rates – with an upward bias for the NZD likely this year and next given the chances that our monetary policy tightening comes before moves in other countries. 

If you want much more information on the NZ economy and housing market in particular you can sign up for my free Tony’s View weekly at www.tonyalexander.nz