Fonterra Co-operative Group has reduced its forecast farmgate milk price for the 2014/15 season from $7.00 to $6.00 per kgMS.
That represents a total drop in payments to farmers of nearly $1.6 billion from their earlier forecast.
A drop in the milk price from $8.40 last season to $6.00 this season will amount to a reduction in the collective income of New Zealand dairy farmers of around $4.3bn, or 1.9% of GDP.
Today's announcement was lower than most in the market were expecting, and will come as a shock to farmers, Westpac chief economist Dominick Stephens said.
"This forecast is one more reason to expect further downward pressure on the New Zealand dollar," he said. "We expect the NZD to drop to 84 cents in the weeks ahead, and we are forecasting an average exchange rate of 83 cents over the remainder of 2014."
The dollar dropped 0.4 cents against the US dollar after the announcement.
Fonterra has also announced an estimated dividend range of 20-25 cents per share - amounting to a forecast cash payout of $6.20-$6.25 for the current season.
Chairman John Wilson said the lower forecast farmgate milk price reflected continuing volatility, with the GlobalDairyTrade price index declining 16 per cent since the start of the season on June 1.
"We have seen strong production globally, a build-up of inventory in China, and falling demand in some emerging markets in response to high dairy commodity prices. In addition, the New Zealand dollar has remained strong. Our milk collection across New Zealand last season ending 31 May 2014 reached 1,584 million kgMs, 8.3 per cent higher than the previous season.
"This drop in the forecast farmgate milk price will have an impact on our farmers' cash flows. We continue to urge caution with on-farm budgets in light of the continuing volatility in international dairy markets," said Mr Wilson.
Chief executive Theo Spierings said the increase in the co-operative's expectations for improved returns on its value-add and branded products, given volume increases and lower input costs.
"As we continue to drive for growth in our consumer and foodservice businesses, during the first half of the current financial year we expect reduced cost of goods arising from lower dairy commodity prices to have a positive impact on returns.
"It is important to note that in light of the significant volatility, our dividend estimate is based on zero ingredients stream returns at this early stage in the season.
"Our forecasting anticipates some recovery in global dairy prices but it is too early to predict how strong this recovery will be or when it will kick in.
An update on business performance would be made when the company announces its annual result on 24 September 2014, Spierings said.