Stronger commodity prices take sting out of high dollar

Prices for major export commodities continued to strengthen on world markets last month, taking the sting out of a strong exchange rate for nearly half the export sector.

ANZ's world commodity price index rose 0.5 per cent to be 17 per cent up on a year ago.

But when converted into New Zealand dollars, the index fell 1.4 per cent and is only 6.4 per cent higher than a year ago.

ANZ economist John Bolsover said dairy prices were at their highest since 1996, lamb prices the highest they had ever been in the 19-year history of the index and beef prices were at historically high levels, though off their peak in September.

He said dairy prices rose 3.1 per cent last month as mixed seasonal conditions kept the lid on production here. Australian production was still struggling to recover from drought during the previous two seasons and European production was also lower.

Lamb prices, up 2.1 per cent last month, have benefited from a tight supply/demand balance, especially in the European market, which accounts for nearly two-thirds of New Zealand exports.

Bolsover said sheep numbers in Britain had fallen after the outbreak of foot and mouth in 2001 which resulted in a 13 per cent drop in the breeding flock. Uncertainty created by the Common Agricultural Policy had hindered flock rebuilding.

Timber prices, on the other hand, fell 10.8 per cent last month, reflecting a seasonal fall as the northern winter approached, and a wave of late-arriving supplies.

ANZ economists say the strong rise in world commodity prices, which over the past year has outstripped the dollar's appreciation, has insulated about half of the export sector from currency strength.

Even though the Reserve Bank has raised the official cash rate 1.5 percentage points, the impact has been blunted by low fixed lending rates, reflecting competition among the banks, and low international interest rates for two-year money.

The economists say that overall monetary conditions are not nearly as tight as suggested by traditional measures, which look only at short-term interest rates and do not adjust exchange rate movements for commodity price changes.

They conclude that the Reserve Bank need not be "bullied" into an easing bias purely because of the higher exchange rate.

"Commodity prices are a critical support pillar to the economy and this currency cycle is looking increasingly different to previous cycles owing to the buffer provided by strong international commodity prices.

"Monetary policy looks set to be on hold for an extended period unless the support provided by commodity prices suddenly dissipates, or the currency rises another 5 per cent and commodity prices do not follow suit."