Tight supply drives milk price higher

The rise in milk powder prices is good for dairy farmers but volatility lies ahead. Photo / Sarah Ivey

The price of whole milk powder has hit a 15-month high but an economist warns the strong rebound could run out of steam if farmers ramp up supply.

Fonterra's monthly internet-based dairy auction rose 3.6 per cent yesterday - the fifth month in a row that prices have increased.

The average whole milk powder price across all contracts and contract periods was US$3560 ($4902) a tonne - US$123 higher than the November auction.

Fonterra global dairy trade manager Paul Grave said while the price increase was smaller than in previous months it was positive to see it stabilising above historic price levels.

Whole milk prices hit an all time high of US$5000 per tonne in 2007 but plunged in the wake of the global economic crisis.

But since July, they have risen 95 per cent. Grave said the price rise showed the market continued to be underpinned by tight supply conditions.

This time of year is typically the slower season for Northern hemisphere production and supply in Australia has also been down.

But Grave warned the price could be volatile in coming months given the fragile economic outlook.

"A sustained recovery is still reliant on strong consumer demand," he said.

Westpac chief economist Doug Steel said the whole milk powder increase was another positive sign for the dairy industry and the New Zealand economy.

But longer term forecasts showed there was greater uncertainty.

Future contract trading showed the average milk powder price was expected to be up 5.1 per cent in February and rise 4.3 per cent between March and May but stretching out to the July to August period it was only expected to be up 0.9 per cent.

Steel said short-term lack of supply was pushing up prices and demand from consumers was also growing, particularly in Asia.

But the higher prices seen in the last couple of months could also drive a higher level of productivity which could hit the price.

"The question is how much is this going to induce supply down the track?"

Steel said market supply was tight but it was difficult to know what Europe or the United States would do in response to the quick price rebound.

The US is predicting its production rates will be down by one per cent next year but Steel said all it would take to affect prices is for that to change to a one per cent increase.

"Prices will be pretty well supported but a supply increase could see a dip in price next year."

Steel said New Zealand production had been up slightly this year, but the North Island had been down while the South Island has been boosted by the number of dairy conversions.

Fonterra's second month of trading for Anhydrous Milk Fat, a product used in making chocolate, icecream and cheese, was less successful. The average price of AMF fell 8.6 per cent to US$4349 per tonne.