On the back of a slowdown in the Chinese economy late last year and in the early part of this year, Chinese consumer demand has started looking a bit wobbly.
Although it can be tricky to get accurate data on the mood of Chinese consumers, a new consumer confidence survey commissioned by Westpac does go some way to filling the gap.
In June, this survey showed a sharp deterioration in confidence, probably not helped by ongoing weakness in the housing market.
And with Chinese wholesalers having apparently built up more than sufficient stocks of dairy products early in the year, price action has been exacerbated by a classic inventory cycle.
The good news is that recently Chinese authorities have once again loosened the reins -- and the latest Chinese GDP data suggested the economy has started to respond. Eventually, this pickup, combined with dwindling inventories and a seasonal lift in demand should spill over to improved prospects dairy prices.
We're expecting prices start to recover in the final quarter of this year.
Yet even with this anticipated pickup in prices later this year, the extent of recent falls, in conjunction with the persistently high NZ dollar has seen us substantially revise down our milk price payout forecast for the current season to $6 -- a far cry from last season's $8.40.
Farmers facing a big drop in revenues aren't the only ones frustrated by the persistent strength of the New Zealand dollar in face of falling export commodity prices.
The current level of the exchange rate has also drawn the ire of the Reserve Bank. In its July OCR Review, the Bank sent a shot across the bows of foreign exchange markets by noting that the failure of the NZD to adjust to weakening commodity prices made the level of the NZ dollar "unjustified and unsustainable and there is potential for a significant fall." language deliberately chosen to highlight the possibility of the RBNZ intervening in foreign exchange markets by selling NZ dollars.
Such a strategy may be more opportune, now that the Reserve Bank has explicitly signalled a pause in its OCR tightening cycle.
After raising rates at every opportunity since March, lifting the OCR to 3.5 per cent, the Bank has indicated it will now take time to assess the impact of these rate hikes on the economy.
But a word of warning -- this pause doesn't mean further rate hikes are off the table. The economy is still growing faster than its non-inflationary "speed limit" and the construction boom is clearly putting pressure on resources which will in turn generate inflation pressure.
We expect by January the Reserve Bank will be back in tightening mode, and continue raising rates at a more gradual pace next year.
