KEY POINTS:
If troubles come in threes, drought is shaping up as the third member of an unholy economic trinity this year, joining a housing-led domestic slowdown and a US-led global one.
Drought was one of the factors that tipped the country into recession in 1998, coming on top of the Asian financial crisis.
Agriculture Minister Jim Anderton is to meet farming leaders next week to discuss the effect the continuing dry weather is having in several regions throughout the country. The National Institute of Water and Atmospheric Research says soil moisture deficits are extreme in Auckland, Waikato, King Country, South Taranaki, Wanganui, northern Manawatu, from northern Hawkes Bay to Wairarapa, and from central Marlborough to central Canterbury. Even parts of Southland are dry.
"These areas require good quantities of steady rain over several days to soak into the soil and revive pasture and river flows," NIWA says.
Its outlook for the next three months is for normal rainfall over the North Island and the top of the South Island but it expects below normal rainfall and soil moisture conditions for most of the South Island, and above average temperatures for the whole country.
ANZ Bank reminds us that the hot summer follows a difficult spring with cold and windy or wet and windy conditions limiting pasture growth in much of the country.
Milk production is plummeting, particularly in Waikato and the Bay of Plenty, which account for about 40 per cent of country's dairy herd, it says, and estimates of a 2 or 3 per cent rise in national dairy production this season are now looking optimistic.
With costs rising but production volumes under pressure, dairy farms' cash surpluses this season may only be 10 to 20 per cent above last year, the bank says, even with prices at very high levels.
And those prices show signs of having peaked.
ANZ's commodity price index dropped last month for the first time in 18 months, reflecting a 5 per cent fall in world dairy prices (though they are still 63 per higher than a year ago).
Meanwhile lambs are being sent to the works lighter than usual and the cull of ewes is being stepped up.
Drought is not just an issue for the farm sector.
It also matters for electricity consumers since most of the power we use comes from hydro schemes.
At a time of year when lake levels should be rising they are not.
The amount of energy stored in the southern hydro lakes is at least 20 per cent lower than normal. One thing that has not evaporated in the summer heat, however, is demand for the New Zealand dollar.
It is threatening the psychologically important US80c again, though on a trade-weighted basis it remains about 4 per cent below the thin-air heights it reached in July last year.
It's all about yield and risk.
What keeps the New Zealand dollar high is that investors reckon the gap between the interest rates available here and those at home more than compensates for the risks, especially the exchange rate risk, in buying New Zealand dollar-denominated securities.
That is despite the fact that the global appetite for risk has fallen sharply over recent months.
There are ways of measuring this which tell us that risk appetite is at its weakest for at least four years.
It seems to oscillate wildly from day to day, like the mood swings of a manic depressive who is not taking his medication. As for the yield gap, it has widened dramatically.
Over the past six months the gap between the official cash rate and its US equivalent, the Fed funds rate, has widened from 3 to 5.25 percentage points.
For businesses and household borrowers what matters is not where those policy rates are now but where the markets expects them to go over the next year or two.
Unfortunately there is not much joy there either.
Reflecting on a turbulent January, the Bank of New Zealand notes that two-year swap rates (the key rate for two-year fixed-rate mortgages) fell by 32 basis points last month in New Zealand.
But even so, the spread between New Zealand and US swap rates widened to more than 5 per cent, wider than the 3.5 to 4 per cent range seen in 2003 when the Fed funds rate was down at 1 per cent.
The markets expect the US Federal Reserve to have cut the Fed funds rate by another full percentage point, to 2 per cent, by the end of the year.
But the Reserve Bank here is not expected to start easing much before then.
Market prices are likely to anticipate that move, however, as the year goes on and evidence mounts that the New Zealand economy is slowing.
The BNZ expects the gap between New Zealand and US interest rates to narrow.
It bases that partly on the expectation that concerns about the possible inflationary consequences for the US economy of cutting interest rates aggressively will push longer-dated US interest rates up.
On top of that slower global growth will adversely affect commodity exporting countries like New Zealand, raising the chances of interest rate cuts and sending the exchange rate lower.
The BNZ believes we have seen the cyclical high of the kiwi against the US dollar and expects it to fall to US74c by the end of the year.
Even if it is right - and accurately picking where the exchange rate will be by a given date is more luck than science - a 74c dollar is hardly likely to trigger a Hallelujah chorus from exporters. Estimates of fair value tend to be in the mid-60s.
Researchers at the Treasury looking at the factors which threw the business cycle around in the 1980s and 1990s concluded that the strongest international factor was export commodity prices, and the strongest domestic factor was weather.
Both were more important that the exchange rate. But the exchange rate is an important buffer. It spreads the gains from rising export commodity prices more widely in the economy by making imported goods cheaper, at the expense of moderating exporters' returns in New Zealand dollar terms.
Over the past two years ANZ's commodity price index has risen 41.5 per cent in world price terms but only 30 per cent in New Zealand dollar terms.
But it works on the way down as well. The currency's weakness early this decade more than compensated exporters for the drop in commodity price following the Asian crisis; in New Zealand dollar terms their returns were comparable to what they are now.
The past is not always a reliable guide to the future, however. It remains to be seen whether the traditional gravitational pull of commodity prices on the currency holds good.
Much of the world is still awash with cash seeking a high yielding home and if anything is clear from the state of offshore financial markets right now it is that they are not always very good at appraising risk.
That could keep the kiwi dollar painfully high for quite a while yet.
