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Dairy prices and the NZ economy

-Press Release

Tuesday 12th June 2007

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Reserve Bank Governor Alan Bollard said today that the current trend in commodity prices, especially for dairy, is very good news for the New Zealand economy, though it presents some challenges for monetary policy.

In a speech to the Waikato Grasshoppers, Bollard said the Bank is analysing the developments in the dairy sector and will remain focused on medium-term inflation pressures.

Bollard said that from a monetary policy perspective, a terms of
trade shock of this magnitude poses some challenges.

"It will affect inflation by creating higher domestic dairy product prices and the higher dairy prices will provide a substantial boost to rural incomes.

"Of course this is great news. However, we are dealing with a stretched economy at present. Domestic demand is already strong and capacity is tight.

If this extra income is spent and/or invested by farmers it will add to this domestic demand pressure."

Bollard said that any predictions of future dairy prices would
involve a range of uncertainties.

"However, current spot market shortages do seem to suggest dairy prices are likely to remain at high levels in the short term, and there is no compelling reason to suggest that strong global demand for dairy products will slow markedly anytime soon," he said.

"As noted in our June monetary policy statement, while there are
uncertainties about the future path of these prices, the increases will assist in narrowing New Zealand's trade deficit.

The rise in dairy sector incomes will provide a substantial boost to economic activity over the next few years, but, to the extent the income boost is spent, will also add to inflation pressures," said Bollard.

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