Buoyant terms of trade tipped to stay

By BRIAN FALLOW economics editor

Despite rising oil prices, the terms of trade went from strength to strength in the March quarter and the Reserve Bank expects them to be a source of buoyancy in the economy for the next couple of years.

The terms of trade index measures changing relative prices between exports and imports. The March quarter's 2.1 per cent increase means that 2.1 per cent more imports could be funded by a fixed quantity of exports - more DVD players, say, for a tonne of skimmed milk powder.

Exports prices fell 1.6 per cent in New Zealand dollar terms in the quarter, but import prices fell 3.6 per cent.

Over the year ended March export prices fell 4.9 per cent but import prices dropped more than twice as much, 10.4 per cent. This has pushed the terms of trade 6.2 per cent over the year to a high level by the standards of the past decade.

Despite a stronger world economy, global overcapacity in a lot of sectors has weakened the pricing power of manufacturing firms.

The Reserve Bank expects the terms of trade to add 0.2 or 0.3 per cent to economic growth over each of the next two years, providing a partial offset to the lagged dampening effect of the strong rise in the exchange rate up until last March.

In Thursday's monetary policy statement, the bank said world commodity prices stood at very high levels and the indications were that that strength would continue in the near term.

"However, based on past relationships current price levels are higher than can be explained by the current state of world demand," it warns. It expects that over the coming months the special supply factors such as the lingering effects of drought in Australia which have supported the world price of our commodities to dissipate and world commodity prices to ease.

But although the bank still predicts a fall in the terms of trade from their current very high level, it now expects them to be more favourable than it did in March. Combined with the lower exchange rate that means healthier export incomes to underpin the domestic economy.

Citing intentional consensus forecasts, the bank's economic projections assume oil prices will fall to around US$30 a barrel by this time next year from recent highs above US$40.