Sub-$6 milk solids price a looming possibility

The possibility of a sub-$6 a kg milk solids price for the 2014-15 season is rising as dairy prices remain under pressure.

An 8.9% drop in this week's GlobalDairyTrade auction resulted in whole milk powder prices falling 10.9%, anhydrous milk fat down 10% and skim milk powder down 7.1%.

It was on the back of a 4.9% fall in the previous fortnightly auction and prices were now down by about a third on the same time a year ago, ASB rural economist Nathan Penny said.

ASB has cut its forecast to $6.20 a kg/ms on the assumption that prices first stabilised and then recovered over the remainder of the year.

''This is the view we have maintained over much of the year, but that view is clearly now under threat,'' Mr Penny said.

He expected Fonterra would revise its current $7 forecast ''before too long''.

Price pressure firstly came from a stellar New Zealand production season, while production had also risen strongly in Europe and, to a lesser extent, the United States and China.

There had been lower demand and Chinese buyers, in particular, appeared to have stockpiled dairy products. The Chinese economy had also slowed over the year.

''Extrapolating these trends would take dairy prices down further. And, in such a scenario, a sub-$6 milk price is a possibility.

''However, we expect a rebound in dairy prices as some of these factors are one-offs.''

Westpac senior economist Anne Boniface said the bank did not think the slowdown in China would be permanent. However, the outlook for the Chinese consumer remained ''wobbly'' in the near term.

That could mean dairy prices softened a little further over the next few auctions, she said.

She expected the auction results would be ''one of the key pieces of news'' digested by the Reserve Bank ahead of next week's official cash rate review.

The fact the currency markets had largely ignored the substantial fall in dairy prices since February would be compounding the impact on the bank's inflation forecasts, potentially leaving it pondering whether it needed to be in such a hurry to raise the OCR again next month, she said.

ANZ economists said the recent dairy price action was a clear reminder the historical experience with commodity price cycles was that booms tended to be ''short and sharp''.

It was also a reminder that swings in the Chinese economy and the wider supply side dynamics across the dairy sector should never be underestimated.

Price falls of that magnitude and a stubbornly high New Zealand dollar represented a material change to the risk profile for the economy, and the interest rate and exchange rate outlook.

Federated Farmers dairy chairman Andrew Hoggard said there would be ''belt-tightening'' among farmers.

He was also predicting a big fall in dairy farmer morale when Federated Farmers' new-season farm confidence survey was released on Sunday.

He recommended farmers that start planning for payout forecasts being predicted by the banks of between $6 and $6.25 a kg/ms.

A $6 payout was the practical break-even for about 20% of the industry with high production costs, he said.

They should be conservative by focusing on debt and prioritising productive investment.

Federated Farmers hoped the Reserve Bank was ''taking note'', with interest rates ''seemingly decided by Auckland's house market and the Christchurch rebuild''.

''It makes for a triple whammy if the forecast payout heads downhill, a high dollar and the risk of an official cash rate hike,'' Mr Hoggard said.

Labour's finance spokesman David Parker said the fall in milk prices showed New Zealand needed an economic upgrade to limit its over-reliance on the dairy industry, with dynamic industries such as ICT, wood processing and manufacturing also contributing to growth.

At a glance
 •A sub-$6 a kg milk solids price possible for current season.

 •Auction prices down a third on this time last year.

 •Chinese demand has slowed.

 •Fall in dairy farmer morale expected.

 •However, we expect a rebound in dairy prices as some of these factors are one-offs



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