Further drop in dairy prices forecast

Traders continue to price in substantial declines given that milk production is up in many regions around the world.

NZX dairy futures prices are trading at a discount and traders predict further falls in the aftermath of this week's GlobalDairyTrade auction.

In whole milk powder, the August NZX futures contract is now priced at US$1570 a tonne, September US$1580/tonne and October US$1630/tonne - all at a big discount to physical market.

Auction volumes are set to considerably increase over the next three months and given some volume on Thursday's GlobalDairyTrade auction may have gone unsold, Nigel Brunel, director financial markets at OMFinancial, said.

"As prices did not clear reserve prices, it is hard to be bullish on the dairy front at the moment," he said.

Traders continue to price in substantial declines given that production is up in many regions around the world.

Whole milk powder prices - which make up about 75 per cent of Fonterra's farmgate milkprice - dropped by 13.1 per cent to an average US$1848 a tonne on Thursday - well short of the US$3500 a tonne required for the co-co to meet its current 5.25 per kg of milksolids forecast. Fonterra will consider the forecast at its board meeting on August 7.

Dairy NZ estimates $5.70 a kg to be the break-even point for most farmers. Prices, after a steep decline in 2014, bounced back in February but have been falling ever since. Oversupply, slack demand from the world's biggest importer - China - Russia's import ban, the removal of quotas in Europe and higher production have all acted to depress dairy prices.

Economists expect prices to stay low before the balance between supply and demands starts to improve next year.

The Reserve Bank has flagged a weak dairy sector as one of three key risks to the nation's financial stability, saying about a quarter of farmers were in negative cash flow.

The bank cut its official cash rate by 25 basis points to 3.25 per cent on June 11 and financial markets expect two more cuts by the year's end.

ASB expects that if production increases for a third year, Fonterra's $5.00/kg forecast will be at risk.