Strengthening NZ dollar, increased output from Europe and reduced imports from China add to poor outlook.

Dairy prices look likely to fall this week as the market buckles under the weight of increased supply from major European Union producers and as the strengthening New Zealand dollar once again fails to provide any cushioning effect for local exporters.

The GlobalDairyTrade price index has only managed to post one small gain - 1.4 per cent on March 2 - so far this year while all other sales have registered declines. Futures market pricing suggests a small decline is on the cards at Wednesday's auction.

"Futures premiums (to GDT) continue to be eroded so I would not be surprised to see prices at the next event to be down as well," Nigel Brunel, director financial markets at OM Financial said. "There are still a few days to go but the market just feels weak."

ANZ agri economist Con Williams said the news flow had not been overly positive for the sector over the last few weeks. "China's dairy imports over February were not great, stocks are high in the United States, and the milk flow in the major producing countries - particularly Europe - continues to grow," he said.


To add insult to injury, the New Zealand dollar - despite a sharp pullback in the aftermath of last month's surprise rate cut from the Reserve Bank has gone from strength to strength, further eroding the value of export receipts.

The Reserve Bank's Trade Weighted Index is now 4 per cent higher than mid-way through last year, despite four successive interest rate cuts from the central bank over that time.

"This resilience is in part a result of how high New Zealand interest rates are relative to other countries, which is attractive to investors," ASB Bank said. Declines in the USD have been more dramatic than we expected, which has supported the Kiwi, ASB said.

The resilience of the NZ dollar is one of the main reasons and others expect the official cash rate to be cut to 1.75 per cent from the current 2.25 per cent later this year. Most dairy farmers are now producing milk at well below the average break even point of $5.25 per kg of milk solids.

There are still a few days to go but the market just feels weak.


Fonterra has confidence that the market will will come back into equilibrium and that dairy prices will reflect that over the next six to 12 months, but others are not so sure.

Matt O'Regan, chairman of the country's second biggest dairy cooperative, Westland Milk, fresh back from Europe to meet customers, farmers, processors, traders and trade policy advocates, said the news from the continent was not good.

"The milk growth rates in Europe are increasing rapidly and expect this to continue for at least 2 years until economic or environmental factors constrain these farmers," O'Regan said in note to suppliers.

Certainly the latest data from the EU does not make for easy reading; wholemilk powder production in the month of January was up 23 per cent on same month last year, and skim milk powder production was up 12.5 per cent over the same comparative months.

Even domestically, production has continued to run at relatively high levels as drought effects from the El Nino weather pattern failed to materialise for most parts of the country.

Dairy Companies Association of New Zealand data for February showed milk production was up 5.7 per cent compared to the same month last year. Credit ratings ratings agency Fitch said growth in global milk supply continues to delay a recovery in milk prices.

This has been compounded by weak demand growth globally, mainly due to subdued Chinese demand and a Russian embargo on major Western dairy exporters, it said.

Fitch believes the recent volatility in global dairy prices is likely to continue in the medium term. However, in the longer term, the fundamentals of dairy demand remained strong.