However, from a monetary policy perspective, a terms of trade shock of this magnitude poses some challenges. It is likely that higher dairy prices will affect inflation in a number of ways. Firstly, as alluded to previously, increases in world dairy prices will lead to higher domestic dairy product prices. This has already begun to occur.
Milk and milk based products are part of the CPI, increases in domestic dairy prices are likely to have a fairly prompt (though likely small) impact on CPI measured inflation. Secondly, and most importantly, higher dairy prices will provide a substantial boost to rural incomes. Of course, for many this is very good news. However, we are dealing with a stretched economy at present.