Dairy farmers greeted Fonterra's improved farmgate milk price with cautious optimism today but the sector, which has suffered two successive seasons of financial losses, has a long way to go before it returns to profitability.

Fonterra said it had raised its farmgate milk price forecast for 2016/17 to $4.75 per kg of milksolids, up from a previous forecast of $4.25/kg.

Combined with the forecast earnings per share range for the 2017 financial year of 50 to 60 cents, the total payout available to farmers in the current season is forecast to be $5.25 to $5.35 before retentions, it said.

The total payout to farmers for the current season is now expected to be about $5.15 a kg - marginally ahead of DairyNZ's estimated break-even point of $5.05/kg.


"It's welcome news - and that would be an understatement" Federated Farmers Waikato chairman Chris Lewis said.

Fonterra said global milk prices remained at "unrealistically low" levels, but have started to improve as global demand and supply continued to rebalance.

"Milk production in the EU is now in decline and our New Zealand milk collection at this early stage is around 4 per cent lower for the year to date," chairman John Wilson said.

Wilson said prices have increased on GlobalDairyTrade but the strong New Zealand dollar continued to offset gains.

Fonterra expects the dairy market to be volatile over the coming months.

GlobalDairyTrade prices went through a similar spike last year, which has made farmers cautious.

Like last year, this year's price strength appears to be driven by renewed demand from China as buyers seek to cash in on the NZ-China free trade agreement (FTA) - which allows importers to land product on the mainland at preferential tariff rates - before the December cut-off.

Farmers have endured two seasons of very low farmgate milk prices, requiring many to lean heavily on their banks for support.


Last year, dairy industry debt stood at $37.8 billion, up from $30 billion five years ago.
The Reserve Bank, in its May financial stability report, said problem loan levels in dairy were expected to increase significantly over the coming year.

Lewis said it would take three good years for farmers' finances to recover from the past two poor seasons.

"It's positive news - don't get me wrong - but after being beaten up for a couple of years, it's going to be hard for farmers to get out of their shell," he said.

Lewis said the pressure would now be on the dairy companies to perform in order to return more money to farmers.

At last week's dairy auction, the GDT Price index gained 12.7 per cent, driven mostly by an 18.9 per cent spike in whole milk powder.

Futures market pricing has also been strong, but much will depend on how the market performs over the peak months of October, November and December.

"If you look at the market conditions and what has caused the quite dramatic improvement over the last two auctions, it has been about China buying in the FTA window, and tighter supplies in New Zealand," ANZ rural economist Con Williams said.

ASB Bank rural economist Nathan Penny said rapidly falling global production has been the catalyst for the price correction on global markets.

Penny, who is at the optimistic end of the market, expects the final milk price for 2016/17 to come to $6 a kg.

"In addition, we expect the global supply correction to accelerate, and for this to lift dairy prices further this year," he said.

ASB estimates that the NZ dairy herd has shrunk an unprecedented 5 per cent or 300,000 cows on top of the 3 per cent fall last season, which would translate into a 5 per cent fall in production this season.

"Similarly, our view is that the EU production slowdown is more advanced than most other analysts are currently factoring in," he said.

Fonterra reports its annual result on September 22.