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Special Topic:  The impact of food and energy prices on the New Zealand economy

Global food and energy prices have risen to their highest levels since the early 1970s driven by sustained periods of growth in the emerging economies, production shifting to biofuels and bottlenecks in global supply channels.  High world prices have flowed into New Zealand consumer prices, stretching household budgets.  The impact of higher prices for staples like milk and petrol is immediate, but what are the wider implications of rising food and energy prices?

With a large agricultural surplus, New Zealand is one of the few economies well placed to meet the challenge of these high prices.  Food exports are a large component of New Zealand’s merchandise exports, and price rises for these exports lead to a higher terms of trade, raising incomes or nominal GDP.  In addition, New Zealand is also not as vulnerable to oil price shocks as in the past.  Overall, the higher costs faced by households must be weighed against the benefits of a high terms of trade. 

Global food price boom now following resource boom

Industrialisation in emerging economies, especially China, led to a resource boom, pushing up prices for metals and energy.  These economies are now enjoying the benefits of rapid economic growth with higher incomes leading to demand for other commodities (and higher prices), in particular for food (Figure 9).  As incomes grow in these countries, food preferences also change towards a diet with more protein, thus amplifying the increase in demand for products such as meat and dairy, which in turn increases the demand for grains as stock feed.

Figure 9 - Commodity Price Index ($US)
Figure 9 - Commodity Price Index ($US).
Source: The Economist

While the sustained income growth in emerging economies is the major driver of commodity price growth, other factors have also contributed.  Supply disruptions, including drought in Australia and geo-political events in several oil producing countries, have restricted both oil and food supplies.  In addition, climate change and energy security policies promoting biofuel production have led to agricultural resources switching out of food production.  And more recently, investors have turned to commodity markets looking for better returns, following slumping equity and financial markets. 

Movements in domestic prices have reflected these global price trends with food and energy prices making the largest contributions to high consumer price inflation of 3.4% in the year to March 2008 quarter.  The Food Price Index increased 6.0% in the year to March 2008 with dairy prices increasing 20%.  Similarly, petrol prices were also up by 20% over the same period.

High food and energy prices lead to tighter household budgets…

Price rises for food, energy and other non-discretionary goods or staples constrain household budgets.  As a result, the higher prices for these staples lead to lower consumption of other more discretionary items like eating out and to the delay of purchases of durables like whiteware and televisions.  Figure 10 shows when inflation spikes as it did in mid-2006, durables consumption tends to fall.  Following the spike in inflation in December 2007 and March 2008, we expect a fall in durables consumption to follow.

Figure 10 - Durables Consumption and Inflation
Figure 10 - Durables Consumption and Inflation.
Source: Statistics New Zealand

New Zealand household spending has begun to reflect this dynamic.  Retail sales fell 0.7% in February after the modest 0.3% rise in January.  Allowing for price increases, these data are consistent with softening real private consumption growth in the March quarter and illustrate the squeeze on household budgets through food and energy prices, not to mention high mortgage rates.  

… although higher food export prices increase both rural and urban incomes…

As a large exporter of agricultural commodities, New Zealand is well placed to benefit from high food prices.  Dairy farmers are already benefitting from high prices with Fonterra forecasting a payout of $7.30 per kg of milksolids for the 2007/08 season, up $2.84 (64%) from last season.  The payout increase reflects high world dairy prices with the average ANZ world dairy price index for the March 2008 year up by 83% compared to the average for the previous year.

While dairy prices have come down from their recent peak, they are expected to remain at a high level.  In addition, the outlook for other agricultural export prices, including meat, is positive.  As a result, we expect agricultural export prices to underpin the terms of trade in the medium term.  The high terms of trade will boost nominal incomes in rural districts such as the Waikato.

The high terms of trade are reflected in the high exchange rate and hence support the real incomes of all New Zealanders.  A strong dollar lowers the cost of imports and allows higher real consumption – cheaper goods means you can buy more of them.  In effect, the high terms of trade lift the exchange rate, spreading the benefits beyond rural areas to urban consumers too.

…while high oil prices impact less than before

New Zealand is also a net importer of oil, so in general, higher oil prices lead to a lower terms of trade and partly offset high dairy prices.  However, New Zealand’s net dependence on oil imports has lessened with increasing local production from the Tui oilfield.  Crude oil is now a major source of export revenue.  In the year to March 2008, crude oil export receipts exceeded each of aluminium, fruit and seafood, reaching $1.8 billion from $0.4 billion in the March 2007 year.  Moreover, the volume of oil exports is likely to grow as more fields come into production. 

Another less direct benefit of high oil prices is their link to dairy prices (Figure 11).  Oil-producing countries, enjoying the benefits of current high prices, are among our largest customers for dairy products.  In the year to March 2008, seven of our top 20 export markets were oil-producing countries, including Saudi Arabia, Indonesia and Venezuela.

Figure 11 - Oil and ANZ World Dairy Prices
Figure  11 - Oil and ANZ World Dairy Prices.
Source: Datastream, ANZ

Fuel and food commodity prices should moderate, but will remain high

We expect fuel and food commodity prices to moderate as producers increase production and speculation in commodity markets decreases.  World dairy prices have already dropped 6% from their peak in November 2007.  However, with the growth prospects of emerging economies still good, we expect commodity prices to remain high by historical standards. 

We expect New Zealand households to adjust their spending patterns to allow for the current high price of fuel and food, resulting in lower real consumption growth in calendar 2008.

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