New Zealand economics comment: More than just milk
New Zealand economics comment: More than just milk
Falling dairy prices have created some doubts about the robustness of New Zealand’s economic boom. But it is worth keeping in mind that dairy is only one part of the economy’s recent growth story. Growth has also been driven by the post-earthquake rebuilding of the Canterbury region, an upswing in housing construction in Auckland and strong net inward-migration. While we expect the recent fall in dairy prices could weaken local income growth, we still expect GDP growth to be above trend in 2014 and 2015. There are also good reasons to believe that the recent slump in dairy prices could prove to be temporary.
Dairy prices have fallen sharply in recent months, with the GlobalDairyTrade price index down by -40% from its recent peak in February. New Zealand's major dairy cooperative has revised down its forecast farm gate milk price for next season to NZD 6.00 per kilogram of milk solids (kgMS), which would be a noticeable hit to farm incomes compared to the 2013/14 season’s NZD 8.40 kgMS payout, if the fall proves to be permanent. If these price levels persist, they could knock as much as 2% of GDP off income growth, although there are a number of mitigating factors.
A key offset will be a likely ramp up in export volumes. To the extent that volumes ramp up without putting significant further downward pressure on prices, this will reduce the negative impact of the recent price fall on incomes. In our view, it is also likely that the dairy price story improves in coming quarters. The fall in dairy prices appears to largely reflect that China ramped up its milk powder inventories substantially in H2 2013 and is now running them down. We expect medium-term demand for dairy products to be well supported, as Asia's middle class incomes rise, although, as with most agricultural commodities, weather-related supply factors and inventory cycles can drive significant volatility around this general trend.
Importantly, New Zealand's recent growth story is more broad-based than just dairy. While the dairy sector is large, it is not dominant: in 2013/14’s stellar production season, dairy exports were worth NZD 15bn, equivalent to around 7% of GDP. Adding in dairy industry support services could boost the share of the economy reliant on the industry to around 10-15% of GDP. Even within the agricultural sector, dairy is not the full story. Meat prices are strengthening and meat exports to China are rising rapidly.
In terms of employment, agriculture is a relatively small sector. In total, 139,000 workers – 6% of the total – are classified as working in agriculture. New Zealand’s economy added +82,500 jobs over the year to Q2, but employment in the agriculture sector actually fell by 8,500 during that time. By contrast, the construction sector added nearly +30,000 jobs.
Construction has been a key driver of recent growth. The post-earthquake Canterbury rebuild, worth NZD 40bn (20% of GDP), is still in its early stages, with over a decade of reconstruction still ahead and the peak contribution to GDP growth not expected until at least 2015. Since the 2011 earthquake, total building activity in the region has measured around NZD 7bn, leaving over NZD 30bn yet to happen. Construction in Auckland is also rising, and should continue to do so, driven by strong population growth and weak housing supply. Central and local governments have recently put in place plans to speed up the growth in Auckland’s housing stock. Meanwhile, a renewed focus on upgrading buildings to higher earthquake standards should also boost construction activity, particularly in the earthquake-prone capital, Wellington.
Despite the fall in dairy prices, sentiment also remains high across consumers and businesses. Business confidence remains at levels implying GDP growth of 3-4%, with business investment and hiring intentions particularly positive. Consumer sentiment is holding up very well, with the quarterly survey remaining near a nine-year high in Q2.
Adding to New Zealand’s growth story, net migration flows have seen a remarkable turnaround over the past couple of years. Annual net migration is currently close to +40,000 (0.9% of the population), which is a huge turnaround from late 2012, when there was net outward migration of around -4,000 people. The turnaround has more than doubled New Zealand’s population growth. The major driver has been trans- Tasman migration, with fewer Kiwis leaving for Australia and a large increase in the number returning home from Australia (the highest rate in over two decades). New Zealand is also attracting more migrants from elsewhere, in particular from China, India and mainland Europe. All of those migrants will need somewhere to live and are expected to add to domestic demand.
Not only is New Zealand proving an attractive place to live, it is also attracting more tourists. Over the year to June, total visitor arrivals were up by +6% from the previous year. Encouragingly, the largest tourism market, Australia, continues to show steady growth despite the lower AUD/NZD. Visitor numbers from China have been the major source of growth over recent years, rising by +30% since June 2012. Tourism and supporting services are estimated to make up around 9% of GDP.
We remain of the view that New Zealand’s growth will continue to be above trend, largely driven by construction and surging inward-migration, which are expected to support domestic demand. At this stage we expect the recent fall in dairy prices will prove to be a temporary supply-side and inventory effect, rather than a permanent decline, although clearly this bears watching carefully.
With growth accelerating over the past year, the RBNZ has lifted its cash rate by 100bps since March. With a pause in the hiking cycle now being signalled, the question is how much more the RBNZ will need to do and when? Despite the fall in dairy prices, we still expect growth to be above trend in 2014 and 2015. Thanks to the strong growth outlook, we expect inflation to rise gradually over the next 12 months. We expect that the RBNZ will need to raise rates further yet, as the cash rate (currently at 3.50%) is still well below its neutral level. At this stage, we still expect another 25bp hike before the end of the year.