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Uh oh, New Zealand’s trade balance ain’t lookin’ too good! The July report showed a deficit of 692 million NZD, larger than the estimated 475 million NZD shortfall. To make matters worse, the June figure was revised lower from a surplus of 247 million NZD to 242 million NZD.

Digging deeper into the numbers of the latest release shows that exports fell by 11.3% during the month, marking its first decline in nearly a year. This was caused by a large drop in shipments of pine logs to China instead of falling dairy exports as many had expected. In fact, exports of milk powder, butter, and cheese were up by 0.9% for July.

The uptick in dairy exports was a bit of a surprise for some market watchers, as sales for these products tend to get weighed down by seasonal factors during this time of the year as calving tend to produce lower milk supply in cold months. To top it off, dairy prices have been dropping for consecutive months, leading to expectations of lower revenues.

new zealand dairy exportsFor most economic analysts though, it’s only a matter of time before the downturn in the dairy industry catches up to New Zealand’s trade sector. After all, New Zealand is heavily dependent on its dairy product exports, which comprise roughly 30% of the country’s total trade activity. The fact that dairy prices have been plummeting for the past seven months due mostly to weaker demand spells gloomy prospects for future trade activity.

The latest Global Dairy Trade auction showed that dairy prices were down by 0.8%, following an 8.4% decline in August 5 and an 8.9% drop in July 15. Looking further back to their peak levels in February shows that prices of milk products are down by 40%, bringing the trade-weighted dairy price index down to its lowest level in two years. Yikes!

Expectations of further price declines could lead to even weaker demand for dairy products, as buyers hold back on purchases in anticipation of cheaper prices later on. As Happy Pip puts it “If I’m expecting a pair of leather boots to go on sale in a couple of months, then I’d wait for those bargain prices instead of buying ’em now. I could be able to buy two pairs for the price of one!”

With that, many are expecting to see a few more months of trade deficits for New Zealand before dairy exports start picking up. After all, whole milk futures for February delivery, which reflect investors’ price expectations for the next few months, are also on the decline. This suggests that market participants aren’t expecting dairy prices to bottom out anytime soon.

Of course this could also have negative repercussions on the domestic economy, as lower revenues from dairy sales mean lower payouts for suppliers. Recall that Fonterra, New Zealand’s largest dairy exporter, already cut its estimated milk payouts to farmers from $7 per kilogram to $6, translating to approximately a 4 billion NZD drop in total farmer income compared to the previous year.

Basic economics tells us that lower incomes tend to translate to lower spending, which could then result to slower economic growth. No wonder the RBNZ decided to pause from its rate hike spree!

With dairy prices and shipments not expected to rebound until the end of year, the outlook for the New Zealand economy and the Kiwi isn’t as rosy as it used to be. Any guesses on when the RBNZ might hike interest rates again?