China's cooling economy to keep prices subdued

Chinese economic growth forecast has been sliced and it's all linked to the Chinese housing bubble bursting. This means a recovery in the farmgate milk price may be months away.

Westpac senior agriculture economist Nathan Penny says the key driver of the weak short-term price outlook is weak Chinese demand, noting that China is by far NZ's largest dairy market.

"Unlike most economies post their Covid lockdowns, China's post lockdown bump in economic activity has underwhelmed expectations," Penny says.

"Indeed, we have progressively cut our outlook for Chinese economic growth for 2023. From 6.2% in June, we have sliced our forecast to 5.7%, and then to 5.2%. If anything, consensus forecasts have stepped even lower, notably for 2024 with the forecast presently sitting at around 4.7% - and this forecast was made prior to very disappointing July data," he says.

Curiously, rising costs of living and/or interest rates do not explain the underperformance of the economy. Consumer prices actually fell a touch over the July year, notes Penny.

"Rather, Chinese businesses and households are suffering a crisis of confidence.

"The housing market remains key to the Chinese economic psyche and any pickup in activity. It remains very weak following the bursting of its speculative bubble and the Government's housing market reforms.

"Officials have begun to incrementally loosen lending policy settings. But further measures are likely necessary. Indeed, we expect additional stimulus, focused on encouraging first home buyers and smaller investors back into the market.

"At the same time, we expect that Chinese officials will try to strike a balance, kick-starting growth in the economy without undoing the hard-won gains from previous reforms.

"Too little stimulus and the economy may stall; too much and a speculative bubble may return. This delicate balancing act results in clear risks to our forecasts for Chinese growth and in turn Chinese dairy demand. If anything, we suspect that the Chinese government may favour less rather than more stimulus than we have factored in."

Global dairy prices have mirrored China's economic struggles. Since the start of the year, dairy auction prices have fallen by around 22%.

Recent falls have picked up pace, with dairy buyer sentiment at a low ebb. At the last Global Dairy Trade (GDT) auction, prices fell 7.4% overall,with whole milk powder prices plunging 10.9%. The catalyst for the price slump was a sudden increase in auction volumes on offer. Ahead of the auction, Fonterra announced a 5.6% increase in auction volumes over the next 12 months.

Penny believes buyers expect prices to get worse before they get better.

"To this end, these buyers may have signalled to Fonterra that they no longer want to buy direct from Fonterra on a contracted basis. As a result, Fonterra has had to shift this product that it would have sold on contract to the auction platform, putting additional downward pressure on auction prices in the short term."

ANZ agriculture economist Susan Kilsby points out that for several decades, China's growing middle class has meant strong demand for dairy products.

"But Chinese consumers are currently saving rather than spending, so there isn't sufficient consumer demand to push prices higher," Kilsby says.

That said, China is still by far the largest importer of dairy products and is buying roughly the same volumes as in the past, she says.

"But as it now has plenty of stock on hand, there is less urgency to secure additional product, so buyers aren't bidding up prices.

"Other markets also have plentiful stockpiles and subdued consumer demand and have similarly low incentives to buy.

"Buyers have defaulted to a 'hand-to-mouth' strategy, buying only what they need. When the market gets a whiff that prices may rise, that strategy is likely to change, and buyers will start bidding to secure product ahead of it, but that may not be until 2024."