Dry conditions in the North Island helped drive milk product prices higher at the latest fortnightly global dairy auction, but ongoing strength in the New Zealand dollar is acting to take the cream off the top for farmer returns, economists said.
Overall, dairy prices rose 3.1 per cent on a trade-weighted basis in the auction, held overnight.
The increase builds on the buoyant start to 2013 in the first three auctions of the year.
Dry weather in the North Island - which is responsible for about 60 per cent of New Zealand's dairy output - is slowing milk production faster than normal for this time of the year.
ANZ Bank rural economist Con Williams said dry conditions were beginning to make their presence felt on production.
"So we are not going to have a strong finish to the season, and it seems that buyers are probably getting in early before prices rise further," Williams told APNZ.
Williams said improvements in the wholesale milk price could add 10c to 20c per kg of milksolids to the current 2012/13 farmgate milk price payout forecast of $5.50 per kg, but with the strong currency continuing to act as a dead weight on returns to farmers.
"If we continue to see this strengthening in prices, as we expect, then that provides a higher starting point for next year but with the New Zealand dollar hovering at around US85c, it is not going to be anything spectacular," Williams said.
Williams said going on current trends, a farmgate price of around $6.00 per kg looked likely for the 2013/14 season.
Westpac economists expect dairy prices to head higher over the first half of this year.
"The tightening supply conditions in New Zealand, coupled with improving Asian growth, particularly in China, are providing upward pressure on dairy prices," they said in a commentary.
Westpac expects the New Zealand dollar to average US86c over 2013, from US84c at present, and for prices to improve in NZ dollar terms, albeit more modestly.
The trade-weighted dairy price index has risen in eight of the last nine auctions. In the four auctions to start 2013, prices have risen by 9 per cent.
Whole milk powder prices - the most relevant for local dairy giant Fonterra - led the way in last night's auction, increasing 5.8 per cent to an average US$3,654 a tonne.
Westpac said the high New Zealand dollar had resent by around 0.2 per cent since the previous auction. After averaging around US$0.81 over 2012, the NZ dollar has averaged around US$0.84 to date in 2013.