Continued weak international dairy prices are expected to limit the ability of our biggest export earner to drag the economy out of recession for at least another year.
Westpac Bank is forecasting Fonterra will pay a milk price this season of $5.10 a kg of milk solids (kg/ms), falling to $4.50 kg/ms next season as the full impact of lower prices hits, then recover to $5.50 kg/ms in 2010-11.
Fonterra in January lowered its forecast payout from $6.60 kg/ms at the start of the season to $5.10, which has put some pressure on farmers' cashflows.
There have been anecdotal claims from financiers that 40% of dairy farmers would either break even or make a loss this year, as many farmers made capital investments early in the season on a forecast milk price of $6.60 kg/ms.
Traditionally, Fonterra has made a low early season forecast and increased it later in the season.
Adding to pressure on cashflow was the deferral by Fonterra until later in the season of paying the added-value component of the payout and delaying by several months until July the payment of higher advanced rates.
Westpac rural economist Doug Steel said New Zealand's lower exchange rate was not expected to compensate for weak international prices, as it had for lamb. Prime lamb prices were almost double what they were last season due in part to an export-friendly exchange rate.
Mr Steel said in his latest "Agribiz" newsletter the weak outlook for international growth would translate into soft demand for dairy products for the next two years and he has forecast world prices to be 64% below their peak levels by the end of this season.
The growth in dairy production of the past few years would have less of an impact on world prices.
New Zealand production was expected to be higher than last year and Australia would also produce more milk as drought pressures eased, albeit off a low base.
However, rising feed prices and falling milk returns have hit the United States dairy industry, resulting in a massive cull of dairy cows and a forecast of a 0.3% decline in milk production compared with a 1.8% increase in 2008.
European milk production would be constrained by lower prices, while increasing market intervention has prompted the European Union to reintroduce export subsidies and both the EU and US have provided dairy product storage programmes.
Export subsidies would put downward pressure on prices by encouraging more product on to the market than would be supplied under normal conditions, while in the short term, the storage assistance would put a floor under prices.
Mr Steel said while forecasting a $5.10 kg/ms payout for this season, there was more chance it would be higher than lower.
