Whole milk power prices dropped to their lowest level since 2008 today, putting more downward pressure on Fonterra's farmgate milk price forecast and reinforcing the market view that the Reserve Bank will cut interest rates twice this year to partly compensate.
At this morning's auction, GlobalDairyTrade index dropped by 9.3 per cent to post its 10th consecutive decline since March. Whole milk powder prices - which largely determine Fonterra's the farmgate milk price - dropped by 10.3% to US$1590 a tonne.
The price of skim milk powder - a key product for the country's second biggest dairy co-op, Westland Milk - dropped by 14.4% to US$1419 a tonne.
At US$1419 a tonne, whole milk prices were well short of the US$3500 a tonne needed to make the $5.25 per kg of milksolids forecast a reality.
Fonterra chief executive Theo Spierings and chairman John Wilson are expected to release a downwardly revised forecast on Friday and some economists predict the milk price could go as low as $3.50 a kg.
ASB Bank senior economist Jane Turner said the auction highlighted the risks to the economy brought on by dairy - the country's biggest export.
"A substantial amount of dairy sector weakness has already been factored in to both our own and the Reserve Bank's forecasts," she said.
ASB expects the dairy market will soon start to stabilise.
"But if we don't see that happening, there are certainly downside risks and a growing case for further interest rate action," she said.
Economists generally expect to see two more official interest rates cuts of 25 basis points each by October, which would take the rate down to 2.5%.
ANZ said the signs were not looking good for Friday's forecast for Fonterra, which will mean a second successive season of low dairy incomes.
"It would not surprise to see prices fall further in the coming weeks and months given the US Department of Agriculture's expectation that global milk production will be a record 580 million metric tonnes in 2015," Nigel Brunel, director financial markets at OM Financial, said.
ANZ said the auction was "about as bad as it could have been".
Since March 4, cumulative fall in average dairy prices has been 46%, taking the level of dairy prices below global financial crisis troughs and to around 12 year lows.
The volumes sold on the GDT portal were significantly up, with 46,527 metric tonnes sold, the highest since last October.
"Given that the next seven auctions account for a significant chunk of annual (GDT) WMP sales, it doesn't take a rocket scientist to work out that auction prices of the next two months will weigh heavily on the final milk price outcome for the 2015/16 season," ANZ said.
The price fall, together with the 3.7% fall in non-dairy commodity prices revealed in this week's ANZ commodity price index, suggested the country was in for a terms of trade hit.
"Monetary conditions need to be more accommodative and the Reserve Bank is likely to follow through with a further rate cut in September," the bank said.
Brian Rice, principal and owner of Chicago-based commodities broking house, Rice Dairy, said the GDT result showed that Fonterra's milk price might struggle to get over $3.00/kg.
"It is not pretty for the global dairy trade and not pretty for New Zealand farmers," he told NZME News Service. "We are close to the bottom but I don't think we are quite there yet."
