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The rising cost of food in New Zealand

Food prices in New Zealand have been rising rapidly over the past year. The Consumers Price Index for the food group showed an annual rise of 5.1 percent in the year to the March 2008 quarter. Price increases for grocery food have been particularly noticeable as shown by figure 1. In the year to the March 2008 quarter, grocery food in the Consumers Price Index rose by 8.7 percent.

Figure 1

Graph, Food Group and Grocery Food Quarterly Indexes.

Large grocery price increases have largely been driven by rapid rises in dairy and grain products. The Food Price Index shows that milk, cheese and eggs rose by 23 percent overall during the year to May 2008. The cost of many dairy products in consumers' shopping baskets have risen significantly in the past 12 months. For example, figure 2 shows that the price of standard fresh milk increased by 22 percent, cheddar cheese by 59 percent and butter by 80 percent.

Figure 2

Graph, Dairy Product Commodities of the Food Price Index.

The most recent annual (22 percent) rise in the price of standard milk is significant, but milk has shown similar gains before. Figure 2 shows that high milk prices tend to be cyclical. Twice in the past decade, there have been rises in the price of milk that have been followed by price falls – for example, milk prices fell in 2003–04 and again in 2006–07. And although milk prices are at an all-time high, this situation needs to be put in context – the May 2008 price is only 8.7 percent higher than the last peak in August 2005.

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Rising dairy prices in New Zealand - a new phenomenon?

In New Zealand dairy price increases are nothing new. Since 1999 prices of dairy products have risen and fallen. Figure 3 shows how milk, cheese and eggs reached price highs during 2001–02, and again (but to a lesser extent) in 2005–06.

Figure 3

Graph, Milk Cheese and Eggs Class of the Consumers Price Index.

However, the extent of the most recent increases in dairy prices far surpasses any of those in the past decade. Before looking into the reasons behind these, it is worth noting that New Zealand's dairy industry is very dependent on the global commodities market. This can greatly affect how much we can export and the prices dairy producers will get for their products.

One of the major reasons for the increase in dairy prices during 2001–02 was the low exchange rate for the New Zealand dollar against the US dollar. As a result, our dollar was worth less in terms of US dollars. Our dairy producers export a large amount of their products and get paid in US dollars – this means that US dollars need to be converted back to NZ dollars so they can be spent or invested at home. Following conversion, exporters received more New Zealand dollars for their US dollars.

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Selling to the rest of the world - the price of New Zealand dairy exports abroad

As the dairy industry is one of our largest exporters, the prices New Zealand consumers pay for dairy products at home tend to reflect what's happening in the rest of the world.

Dairy prices in this country are linked to export prices – when export prices rise or fall, domestic prices generally follow. Recently, export prices have been rising rapidly. For example, the Statistics New Zealand index for export prices in figure 4 shows that dairy prices rose 63 percent in the year to the March 2008 quarter and the index is now at its highest level since records began in 1950.

Figure 4

Graph, Merchandise Trade Export Dairy Prices Index and Average Trade Weighted Index.

It is interesting to look at dairy prices in the countries we export to and compare how prices have moved. Are we better or worse-off in terms of dairy food price inflation?

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International dairy price comparisons - how do we fare against other countries?

The 5.1 percent annual rise for the food group of the Consumers Price Index in the year to the March 2008 quarter shows New Zealand food price inflation was around the same level as many of our major trading partners.

For example, the United Kingdom's food prices rose by 5.9 percent for the year to the March 2008 month, the US Consumer Price Index for food showed an annual rise of 4.5 percent to the March 2008 month, whilst Australia's comparable annual figure was 5.7 percent for the March 2008 quarter.

However, although our food prices are comparable with those in other countries, the 23 percent annual rise in New Zealand's dairy prices (Food Price Index for milk, cheese and eggs to May 2008) was more than double that of the US and Australia. When examining the Consumer Price Index for each of these countries for the year to May 2008, we find that in the US, dairy and related products showed an increase of 11.0 percent while in Australia, these rose 10.3 percent for the year to the March 2008 quarter. Interestingly, this was their largest annual increase in dairy prices for almost 30 years.

The UK's milk, cheese and eggs component of their Consumers Price Index also showed a lower increase than New Zealand – it rose 16.6 percent over the same period.

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Factors influencing dairy price rises

Other developed countries have experienced historically large price rises for dairy products in the past year. This leads onto the question: why is it that dairy prices around the world have risen so much?

Sharply rising dairy prices have been driven by an imbalance in global demand and supply. This is due to rising production costs, increased demand from emerging undeveloped markets, and natural disasters in some of the major dairy exporting countries. These factors are briefly examined below.

Increased cost of production

Dairy farmers have been facing increased production costs as a result of rising fuel prices. Higher fuel prices have led to more efforts to find alternative fuel sources. In recent years, biofuel has become an increasingly popular fuel substitute. Biofuel contains ethanol, much of which is made from corn. With biofuel production increasing rapidly, corn and grains (such as wheat) have become more expensive.

For dairy farmers in many parts of the world, grain is used to feed livestock and higher grain prices have meant increases in production costs.

Rising production costs have hit New Zealand dairy farmers. The costs of production are given by the Farm Expenses Price Index. The index shows that for the year to the March 2008 quarter, feed, grazing, cultivation and harvesting costs for dairy farms were up by 14.9 percent.

Reflecting the big jump in fuel prices, the fuel component of this index showed an increase of 23.5 percent.

Overall, the index for all inputs for dairy farms rose 6.9 percent in the year to the March 2008 quarter.

Increased demand in developing markets

As incomes in many of the emerging Asian markets (particularly China) continue to increase rapidly, the diets of these countries have been changing and moving towards dairy-rich Western tastes. More dairy products are being consumed as they become increasingly affordable.

With developing countries demanding greater quantities of dairy products, this has increased pressure on dairy prices around the world.

Natural disasters

Adverse climatic conditions in 2007 have played their part in causing a worldwide dairy price shock and have severely hampered agricultural production.

Until 2007, agricultural intervention stockpiles in the European Union and the United States were being used to bridge the gap between demand and supply (Source: Rabobank, 2 October 2007). However, by the middle of 2007 these supplies had run out leaving the market vulnerable. With no stockpiles left to draw down, worldwide production suffered as Australia, a major producer, entered its second severe drought in five years. Production was also hit when Argentina suffered from major flooding that affected 30,000 square kilometres of farmland.

The effect of these production constrictions was that supply was unable to meet demand and as a result, dairy prices rose.

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Recent falls in dairy prices

Lately, global prices for dairy products have shown signs of easing. This is supported by the most recent ANZ commodity price index which shows that since late 2007, world spot prices for dairy products have been declining. From a high in November 2007, prices fell 11.0 percent by May 2008.

The Food Price Index also provides evidence that supports a recent slowing in dairy price rises in New Zealand. From a monthly increase of 2.9 percent in February 2008, milk, cheese and eggs fell by 0.3 percent in March 2008. Following a 1.0 percent increase in April 2008, the index fell by 0.3 percent again in May 2008.

The coming months will indicate whether these falls are just a short-term phenomenon.

Back to Price Index News: July 2008

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