Fonterra has just announced it is increasing its forecast milk price payout by 40 cents, to $6.10 per kilogram of milksolids.
Co-op chairman Sir Henry van der Heyden said continued strength in global dairy prices, with demand growth beginning to outstrip supply, had driven the decision to increase the forecast milk price.
This increase is the first since the forecast milk price was raised by $1.10 per kilo of milksolids (kgMS) last November.
Philip Borkin, economist at Goldman Sachs JBWere said the increase in milk price payout would add around $500 million to farm incomes. This was a rise of 0.3 per cent of GDP.
"What farmers choose to do with this windfall is the ultimate question. Those affected by drought may not benefit from the gains (particularly due to lower production levels and likely winter feed costs increases)," said Borkin.
"We also suspect that many will use the windfall as an opportunity for debt reduction or reinvestment in their farms. Therefore we believe the direct monetary policy implications are not as strong as otherwise would be the case. "
Borkin said the impact of the drought is likely to mean that the boost in farm incomes was not spread evenly across the country.
"As we head into winter, those farms with currently poor pasture growth are also likely to have to lift feed costs, impacting cash flow."
"Today's announcement is another piece of positive news flow for the tradeables sector of the economy. In terms of monetary policy implications though, the story is more mixed."
Chairman van der Heyden said the extra 40 cents per kgMS meant the 2009/2010 season was shaping up as the second best in terms of cash payments to Fonterra farmer shareholders.
"However, it comes at a time when many farmers, especially those north of Taupo, are suffering from worsening drought conditions. Many of them are being forced to dry off their herds early this season, so unfortunately what they will gain in farm income through the higher milk price they may lose through lower production," he said.
"Looking forward, we recognise that the weather has made it very difficult for many farmers going into the winter, and that farmers will need to be setting their budgets soon for next year.
He said that a "more formal" forecast would be done at the end of May.
Fonterra Shareholders' Council chairman Blue Read said the combination of milk Price, dividends and retentions meant Fonterra was on track to return for supplying shareholders a total of $6.40-$6.70 kgMS for the full year. That would be well ahead of the combined payout and retention of $5.70 kgMS for the 2008/09 year.
Read said the improvement in milk price was "heartening for supplying shareholders, especially at a time when many have faced the impact of drought conditions and are recovering from volatile markets in the past couple of years."
He said the increase would be welcomed by farmers contemplating further investment in the co-operative.
"It presents an opportunity for farmers to consolidate their personal financial position and if they are in a good position they can invest in the future prosperity of the co-operative," said Read.
In light of the higher milk price forecast, Fonterra has revised the advance rate schedule for milk payments, with progressive increases in payments over the next six months.
Chairman van der Heyden said this would put more money into farmers' pockets sooner - helping farmers with their cash flows while protecting the strength of Fonterra's balance sheet.
The co-op has also maintained its forecast range for the 2009/10 distributable profit of 40-50 cents per share.
Fonterra's target dividend range is also unchanged at 20-30 cents per share; this indicates 10-30 cents per share of distributable profit would be retained within the co-op.
Chief executive Andrew Ferrier said that since the last milk price forecast, dairy prices had remained relatively high and more stable than expected for several months, and had recently increased further.
"The global supply/demand balance for dairy products has shifted to a slight supply deficit. Demand from Middle East/North Africa and Asian markets continues to grow. On the supply side, global milk production has continued to slow, with production contracting in several key markets."
He said that supply had been affected by a tough European winter, while production from Australia and North America was also down.
The drought here in New Zealand meant Fonterra production was likely to be similar to last season. A modest increase had previously been forecast for this season.
Although the net effect was good news for the milk price in the short term, Ferrier said there was still "significant volatility" in the market.
He also said that despite the higher milk price, profits remain as expected, driven primarily by further earnings improvements within the consumer brands businesses and lower overall funding costs.