If you didn’t know about the Strait of Hormuz, you do now. As the world adjusts to the Iran war, the economic impact will be felt for some time. Farming margins are under pressure from cost-push inflation and interest rate strategies are adjusting to higher for longer rates.
Interest rates
- Interest rates to follow the global shock playbook. An initial overreaction, before stabilising as markets refocus on underlying fundamentals, with some bumps along the way.
- The main dilemma is how the Iran conflict will interact with pre-existing economic pressures, namely persistent inflation.
- Opinions vary widely, but the yield curve suggests the era of benign, low interest rates has passed. Higher for longer is now the prevailing theme, with fixed rates briefly reaching above the 5.00% threshold for the first time in over a decade (back to the days of iPhone4).
- Expect the economic fallout from the Iran war to linger and weigh on the growth outlook, as trade disruptions and damage to structural infrastructure drag on global supply chains.
- In this environment, patience and discipline are critical. Borrowers should anchor their interest rate strategy to what the business can sustainably service. Take advantage of any dislocations to fix rates and protect against scenarios where rates move above this level.
Note: Foundation Agri Finance price loans based on the current Australian Dollar ad New Zealand Dollar Interest Swap Rate plus a customer margin. Please contact the team to discuss our competitive fixed-rate options.
What we’re hearing
Diverging farmland returns: Recent farm visits in Australia and New Zealand highlighted the difference in how farmers make money. Between 2010-2024, our analysis shows grain farmers in Western Australia achieved strong annual returns of 15%. In contrast a New Zealand dairy farmer realised 8%, still a solid result. The key difference was capital appreciation. The WA cropper generated 67% of their returns from capital growth whilst the NZ dairy farmer only 23%.
NZ farmers do a good job at generating cash profits. Farmland values however have not followed farm profitability higher. The market has been constrained of capital from both domestic lending (regulatory demands) and foreign capital flows (Overseas Investment Office controls). This dynamic is shifting, providing a tailwind for farmland values.
Australia has the inverse scenario. After a prolonged run of capital growth, farmland values are catching their breath to give operating returns a chance to catch up.
Even with these changing domestic influences, good farmers will continue to be the best performers. They make the most of the opportunities in front of them, investing resources to deliver the best total return on capital.
Opportunities with uncertainty: Sell when most people are buying and buy when they are selling. This mentality comes to mind when looking at the current rural property market. Volatility and uncertainty drives inertia, as many farmers wait for a clearer picture before making major investment decisions. Find ways to make the most of this opportunity and take calculated risks that align with the core business strategy.
Agricultural deal flow in Australia started the year strongly but has slowed. In regions of where sentiment is mixed due to challenging seasonal conditions, vendors are revisiting price expectations and sales structures to better align with buyer demand. Vendor loans and offering properties in lots often helps getting the deal done. An example is Rest Super’s Dalby aggregation in Queensland being split up and sold to three local families.
The themes extend to New Zealand but to a lesser extent given lower interest rates and generally favourable commodity prices. Dairy leads the charge with strong farmgate milk prices and Fonterra’s $3.2 billion payout boosting the average bank balance by $400,000. Heightened dairy property sales activity in 2026 could eclipse 2025 which was the best in a decade according to Real Estate Institute of New Zealand.
Commoditization of agri debt: Same-same and not different. We are increasingly operating in an environment of process-driven, homogenised lending. Lending products and value propositions are becoming more standardised, with less emphasis on long-term relationships. Outcomes are now driven as much by the capability of the relationship manager than the colour of their shirt.
This presents a challenge for agriculture. Farming businesses are inherently diverse and financial metrics alone rarely capture the full picture. Management capability, seasonal conditions and operational nuances often determine performance. A one-size-fits-all approach risks overlooking these critical, albeit subjective factors.
As debt becomes another commodity within farming businesses, the strategic focus needs to shifts. Pricing still matters but don’t forget the value of non-financial aspects like loan duration, covenants/conditions and relationship. Saving a couple of dollars on rate helps but a flexible and resilient debt structure delivers more value long-term.
The Challenge of Cost-Push Inflation: Inflation remains stubbornly high and the Middle East crisis will only exacerbate the problem. Both Australia and New Zealand managed to sneak inflation below 3% before it jumped and started running again. RBNZ’s March annual CPI came in at 3.1% but is now forecast to be above 4% in June. Australia’s CPI jumped to 4.6% in March. Add in the full cost of the Iran war and the central banks’ target mid-point of 2.5% is a long way off.
What makes the current environment more challenging is that the dominant inflationary driver now is cost-push inflation. This occurs when prices rise because costs go up, rather than the more common demand-pull inflation when prices rise because demand exceeds supply. The distinction is important as the implications and solutions vary.
Take an Australian grain farmer we recently visited. A decade ago it cost them about $100 to grow a tonne of wheat. Now it costs closer to $200 due to higher fertiliser, fuel, wages and interest rate costs. Farmers are generally price takers in global markets so passing these higher costs on is difficult. The result? Farmers absorb most of the cost increases and margins get squeezed.
The problem with cost-push inflation is that it’s harder to control. Increasing the cash rate is a central banks blunt instrument for dealing with inflation. It is effective at curbing excess demand in demand-driven inflation, less so combating cost-push inflation. It can lead to further cost increases whilst cooling demand. This risks recession or stagnation, a corrosive mix of high inflation and low growth.
Like most things, solving the cost problem takes time and effort. Governments and business need to collaborate to invest in increasing production capacity, productivity and supply chain infrastructure to drive costs lower.
It took a decade to control cost-push inflation from the 1970s oil crisis. COVID-19 was shorter, although there is an argument we are still dealing with the cost hangover. Either way it’s not a quick fix so plan for elevated costs including interest rates.
Quote of the update
“The government giveth, the RBA may well taketh away” – Saul Eslake, Economist.
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