New Zealand Dollar: Milk, Lamb Price Weakness Confirms Softer Outlook

Image © Adobe Stock

New Zealand can expect to earn billions less in foreign exchange as the price of agricultural commodities comes under pressure, a development that will underpin the New Zealand Dollar's ongoing bout of weakness say analysts.

News that Fonterra has lopped a full $1 from its milk price forecast, and evidence lamb prices are trending lower, will add pressure to New Zealand's foreign exchange earnings potential amidst an already-established downtrend in the NZ Dollar.

"Dairy is NZ’s largest export earner, so material changes are of macroeconomic importance. Lower dairy sector returns will have flow-on consequences through regional areas and the wider national economy," says Doug Steel, an economist at BNZ.

Fonterra caused waves when it dropped its milk price forecast range to 6.25-7.25 $NZ/kg of milk solid for this season. The mid-point of the tighter range is now $7, down fully $1 from Fonterra’s initial forecast range.

"Global dairy markets are continuing to weaken and are now expected to remain soft for the rest of 2023. Global milk supplies are easing, which will help rebalance the market, but at this stage prices are likely to be driven still lower due to soft demand," says Sharon Zollner, Chief Economist at ANZ Bank.

Fonterra - the dairy co-operative - said the revised forecast Farmgate Milk Price range reflects ongoing reduced import demand for whole milk powder from Greater China.

"As dairy prices head back towards 2020 lows the broad correlation with the NZD, currently around 0.74, points towards NZD underperformance," says Jeremy Stretch, an analyst at CIBC Capital Markets referencing NZD/USD's decline.

David Croy, a currency strategist at ANZ says the New Zealand Dollar's recent underperformance "is not surprising given the fall in milk prices."

His economist colleagues at ANZ have on August 10 lowered their farmgate milk price forecast for the 2023-24 season by 60c to 7.15 $NZ/kg milksolid.

"Economic conditions in China have deteriorated further and their demand for dairy products has eased," says ANZ's Zollner.

Above: NZD screened over one month reveals it to be the G10's wooden spoon holder.

The Chinese economy has struggled to fulfil expectations made at the start of the year for strong economic growth amidst a full lifting of Covid restrictions. Weak global demand for goods, a soft residential property sector and cautious consumer behaviour have all contributed to an underperformance in Chinese economic activity that is seen weighing on demand for New Zealand's commodity exports.

The New Zealand Dollar is the worst-performing major currency when screened over the past month having fallen against all its G10 peers.

It is particularly weak on the crosses with the Pound to New Zealand Dollar exchange rate now trading at its strongest levels since May 2016, meaning it has surpassed its post-Brexit referendum level.

Weakness comes as investors continue to bet the Reserve Bank of New Zealand will be amongst the first developed central banks to cut interest rates owing to a soft domestic economic performance, which is being further exacerbated by the weakened demand for New Zealand's agricultural produce.

"Dairy is NZ's largest export and a milk price at this kind of ballpark will be a drag on NZ’s terms of trade and add to the downward pressures on the NZ economy and NZD," says Kristina Clifton, a currency strategist at Commonwealth Bank of Australia (CBA).

CBA's New Zealand subsidiary, Auckland Savings Bank (ASB), has long expected to see a milk price around the sorts of levels made in Fonterra's forecasts, predicting milk to be around the 7.00 to 7.25 $NZ per kgMS mark since the beginning of the year.

But it is not just dairy export prices that have softened with economists pointing to New Zealand's other major primary exports which have fallen in value, including recent material weakness in lamb prices.

AgriHQ figures show lamb prices are around a quarter down on a year earlier and beef prices are relatively better, but still around 10% lower than a year ago.

Above: Lamb prices are also looking soft. Image courtesy of BNZ.

There is little prospect of a pickup in demand for New Zealand's exports for the remainder of 2023 according to the major Kiwi banks we follow, thanks largely to the subdued China story.

"China is currently experiencing a period of deflation. Consumer confidence is weak, unemployment levels are rising, and the property sector is struggling. Exports are also under pressure. All of these factors are encouraging China's consumers to save rather than spend," says Zollner.

All this should extend the New Zealand economy's ongoing weakness and ensure the RBNZ remains confident it made the right choice by ending its rate hiking cycle when the OCR reached 5.5%.

None of these developments suggest a NZD rebound is in the offing.