Fonterra has forecast a $4.25 per kg of milksolids farmgate milk price for the coming 2016/7 season, up from the current season's forecast of $3.90 a kg, but below market expectations of around $4.50.
The New Zealand dollar fell by about one third of a US cent on the news from US67.60c just before the announcement to US67.40c just after.
"Given the recent moderate gains in the GlobalDairyTrade auctions, markets were slightly disappointed in the $4.25 forecast," Westepac senior market strategist Imre Speizer said.
While the forecast for the coming year is an improvement on 2015/6, the milk price remains well below DairyNZ's $5.25 kg estimate of breakeven.
Milk prices are a reflection of low international dairy prices as the market struggles with oversupply, particularly from European Union producers.
Fonterra chairman John Wilson said co-operative's forecast took into account a range of factors including the high NZD/US dollar exchange rate, supply volumes from other major dairying regions, current global inventory levels, and the economic outlook of major dairy importers.
"Conditions on farm are very challenging," he said in a statement.
The strength of the co-operative's balance sheet had allowed it to increase the advance rate in the first half of the new season.
Fonterra would also bring forward payments for this season's milk to assist on-farm cashflows.
"We are expecting global dairy pricing to gradually improve over the season as farmers globally reduce production in response to ongoing low milk prices, however we continue to urge caution with on-farm budgets," Wilson said.
Chief executive Theo Spierings said the long term fundamentals for global dairy remained positive with demand expected to increase by two to three per cent a year due to the growing world population, increasing middle classes in Asia, urbanisation and favourable demographics.
"In addition to global supply growth slowing, we are seeing imports into major dairy markets improving compared to a year ago," he said.
China dairy consumption growth remained positive and its demand for imports had been steady over recent GlobalDairyTrade events, he said.
"It is obviously a pretty conservative start at $4.25 - below the bottom of the range in terms of market expectations," ANZ rural economist Con Williams said. Fonterra's moves to improve farmer cashflows would make a difference for cash strapped farmers, Williams said.
"Increasing the advance rate and obviously paying out dividend income earlier than normal is pretty crucial at the moment because cash flow is still under water for the dairy sector," he said.
Federated Farmers Dairy chairman Andrew Hoggard said farmers were resigned to another tight season.
"Many were hopeful of a price in the vicinity of $4.50, so optimistic farmers will be feeling disappointed," Hoggard said in a statement.
"It is welcome that Fonterra has brought forward the advance rate payments, however we are still dealing with a low milk price, that is undoubtedly still below the break even price for most dairy farmers," he said.
Hoggard said for farmers to survive, maintenance and repairs would continue to be deferred and inputs would be at a minimum. "The flow-on effect of less spending will mean the rest of the rural and provincial economies will also suffer," he said.