KEY POINTS:
Dairy giant Fonterra's 27 per cent projected payout increase to farmers will provide a welcome boost to the rural sector and will help alleviate pressure on the country's current account deficit, but it could also prove inflationary, economists say.
Fonterra expects to pay $5.53 for a kilogram of milk solids in the new season from October, having already raised the payout for the current season to NZ$4.35, up 7.4 per cent on its original forecast.
Commodity prices are being driven by unprecedented market conditions, where strong global demand for dairy products outstripping supply. The expected rise in next year's payout is worth an extra $120,000 to the average dairy farmer, and economists estimate it will add $1.5 billiion to the NZ economy.
Most market economists do not expect to see another rise in the official cash rate from the Reserve Bank this year, but the increased payout will add weight to the argument that says there should be one.
"An extra $1.5 billion is very significant - it's around about one per cent of gross domestic product and that's really only factoring in the first round impacts," Westpac Institutional Bank economist Doug Steele said.
"Once farmers spend a little bit, whether it be on fertiliser or feed or other farm inputs, then that goes through into the next round of spending, so the multiplier effects are likely to give us a considerably bigger boost than $1.5 billion on its own."
Steele said the increased payout would have come as a surprise to the Reserve Bank governor Alan Bollard, despite the central bank mentioning commodities prices in its recent commentaries. He said the Fonterra payout, the extra fiscal stimulus coming from the Budget, evidence the housing market was starting to get a third wind, and retail sales spending being extremely strong in the first quarter, all called into question whether Bollard had the luxury of time to wait.
Westpac expects another rate rise in September, possibly earlier, but the bank is in the minority with that view.
ASB Bank chief economist Nick Tuffley said the payout increase would have a welcome impact on New Zealand's current account deficit, which was big by international standards and represented nine per cent of gross domestic product.
He said the Reserve Bank would examine the implications of the payout, but the household sector remained its biggest inflationary problem. "In terms of their key concerns it will remain very much the household sector rather than the farms."
