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Monthly Economic Indicators

Special Topic: Commodity prices and trade developments

World commodity prices fell sharply over the June quarter but have risen strongly over the past few weeks, driven by a recovery in oil prices and a surge in grains prices to record levels. For New Zealand, the effects of the rise in oil prices are already apparent in retail petrol prices, but it could be several months before food prices are affected. The rise in oil and grain prices is also likely to contribute to falls in the terms of trade over 2012, a widening in the current account deficit and slower growth in nominal GDP. Beyond this year, the rise in grain prices may assist a recovery in the terms of trade.

Higher grain prices...

Widespread drought in the United States has curtailed expectations of corn and soybean yields, driving prices up 50% and 30% respectively since mid-June to record highs (Figure 8). Wheat prices too have increased as production estimates in Russia and the Black Sea region have been lowered. Wheat production in Australia is also at risk with key parts of Western Australia experiencing seasonally low rainfall. Concerns around cereals production in India remain; despite rainfall returning to normal over the past three weeks, monsoon rains are around 14% below average.

Figure 8 – Grain prices surge
Figure 8 – Grain prices surge.
Source:  S&P Goldman Sachs Agriculture Index, Haver

Reflecting these developments, the UN's Food and Agriculture Organisation (FAO) Food Price Index rose 6% in July, driven by a 17% rise in the Cereals Price Index (Figure 9). In July, the Cereals Price Index was just 5% below its April 2008 record, and developments over the past month may have pushed it above this peak. Meat and dairy prices have been declining and rice prices have been stable, unlike the situation in 2007/08 when rising prices for all food types generated popular unrest in a number of countries. Nonetheless, poor production in the southern hemisphere or export bans to secure food production could precipitate another crisis.

Figure 9 – Food prices increase
Figure 9 – Food prices increase.
Source:  FAO Food Price Index

...may increase beef and dairy prices

In the US, where livestock production is dependent on grains, significantly higher feed prices are expected to restrain growth of cattle numbers and reduce milk production. The US Department of Agriculture (USDA) rates almost 60% of pastures in the US as being in poor to very poor condition. The lack of pasture is inducing farmers to place cattle on grain feeds at lower weights, which is expected to flow though to more beef supply at potentially lower prices in the next 6-9 months, but less beef and higher prices later in 2013 and beyond.

Heat stress on dairy cows combined with higher feed costs is expected to reduce output per cow and raise milk prices over 2013, although prices are likely to remain well below their 2011 levels.

Higher oil prices pose challenges

Oil prices fell by around 30% from their peak earlier this year to their trough in June, led down by the worsening macroeconomic outlook. Since then they have regained much of those price falls. The rise in prices is broad based, affecting most of the oil price benchmarks including Brent, Dubai and WTI (Figure 10), indicating that the drivers are more likely to stem from demand. But there are some factors restraining supply including production outages in the North Sea, the Atlantic hurricane season, Iranian oil export sanctions and political tensions across the Middle East more broadly. These factors notwithstanding, OPEC production is at a high level.

Figure 10 – Oil prices recover
Figure 10 – Oil prices recover.
Source:  Haver

On the demand side, seasonal increases are a factor and market sentiment seems to have been buoyed by discussion in Europe, China and the US of economic recovery programmes, despite ongoing weakness in the data. However, this weakness is reflected in falling prices in other energy markets, such as coal and gas, and in iron ore prices.

The rally in prices, combined with its proximity to the US presidential election, has trigged talk of a release of strategic oil reserves in the US to lower prices. A recent report by Barclays identifies two trigger points for the release of oil reserves: the price of gasoline reaching US$4 per gallon and Brent crude over $120 barrel, not too far from today's levels.

With oil prices already incorporating the impact of a recovery in demand, further price gains may be more dependent on supply developments, particularly in relation to the ability of production to expand and offset lower Iranian supply. Conversely, adverse macroeconomic developments are likely to see oil prices retreat.

The coincident rise in oil and grain prices comes at a difficult time for many developed countries, and further increases threaten to undermine already weak demand. In emerging countries too, where these commodities are a relatively large proportion of total consumption spending, the inflationary impacts may reduce the scope for policy to stimulate demand.

Some upside for New Zealand...

Prices at the GlobalDairyTrade auctions lifted over August reflecting, at least in part, concerns around the impact of the US drought on dairy supply over the year ahead (Figure 11). These rises, if sustained, should be reflected in export prices towards the end of 2012/early 2013. An easing in domestic production from last season's high levels is also expected to contribute to a firmer price environment. Despite this, Fonterra has lowered its forecast payout for the coming season as the strength of the New Zealand dollar outweighs gains in international prices.

In contrast to the expansion in dairy supply, global beef supplies have remained tight over the past year and NZ dollar export beef prices have remained firm, up 7% in July 2012 from the same time a year ago. Beyond the short-term drought-induced rise in beef supply and associated fall in prices, the reduced size of the US cattle herd will lead to a further tightening in beef supply and higher prices.

Changes in oil prices tend to translate rapidly into domestic prices and are likely to be reflected in higher September quarter import prices, compounding the impacts of the expected weakening in dairy and beef prices on the terms of trade in the near term.

Figure 11 – NZ food prices slow to respond
Figure 11 – NZ food prices slow to respond.
Source:  GlobalDairyTrade, Statistics New Zealand

For consumers, the rise in grains prices is likely to be reflected in higher food prices. It will take some time for these to filter through (Figure 11), with even longer lags for processed foods such as breakfast cereals, bread etc.

In addition, the proportion of total food costs affected is small (Figure 12), and food costs themselves are only about 20% of the total Consumers Price Index. The USDA is forecasting US food prices to rise by 3.5% in the year ahead.

Figure 12 – Limited impact on food costs
Figure 12 – Limited impact on food costs.
Source:  USDA

...but not this year...

New Zealand's terms of trade (the ratio of export prices to import prices) is expected to decline for the fourth consecutive quarter in June as export prices fall. Merchandise trade figures for the quarter point to some stabilisation in dairy prices, although prices fell sharply in July's trade data as volumes rose sharply. Beef prices firmed in the quarter but weaker lamb prices may cause overall export meat prices to fall. Forestry prices also looked to be weaker, while other export prices including aluminium, fish and wine were up. Falling oil prices in the quarter contributed to a 1.9% decline in total goods import values; export values were down 1.6%, suggesting softer import prices may help to offset falls in export prices in the June quarter Overseas Trade Indexes (OTI) terms of trade to be released on 3 September.

...as the current account deficit widens...

The weakening in export prices and in the terms of trade is also being reflected in a narrowing of the Balance of Payments goods surplus and slower nominal GDP growth. We estimate the annual goods surplus to have closed to 0.6% of GDP in the year ending June 2012, down from 1.4% in March, which contributes directly to a widening of the current account deficit. In addition, the positive tone of recent company reports to the New Zealand share market, including those from the major banks, points to a wider income deficit. Balance of Payments figures for the year ending June 2012, released on 19 September, are expected to show a current account deficit of around 5.5% of GDP, up from 4.8% of GDP in March.

...and nominal GDP growth stalls

Growth in the current price, or nominal, measure of Gross Domestic Product (GDP) slowed to 3.1% in the year ending March 2012, with growth essentially stalling in recent quarters. The modest June quarter CPI outturn, combined with further falls in the terms of trade, points to slow nominal GDP growth in the June quarter and there is currently little to suggest things will pick-up in the September quarter. June quarter GDP is to be released on 20 September.

Nominal GDP is growing more slowly than expected in our Budget forecasts, although much of this is attributable to data revisions, but tax revenues in the 11 months to May were close to forecast. With company profit reports firming over the past six-months or so, there is some upside to tax revenue over the first half of the 2012/13 fiscal year, but with risks to the global outlook skewed towards weaker growth, there is a high probability of persistent weakness in nominal GDP. A key implication of this scenario, which was discussed in the Budget Economic and Fiscal Update, is relatively subdued tax revenue growth and larger fiscal deficits.

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