Prices of dairy products surged to the highest in two years in Fonterra's latest online global dairy auction as drought curtails production in the North Island.

The GDT-TWI Price Index rose 14.8 per cent compared to the last sale two weeks ago, the biggest increase since the September 1, 2010, sale and the seventh straight gain. The average winning price rose to US$4,683 a tonne from US$4,216 a metric tonne. Whole milk powder, the biggest product by volume, jumped 21 per cent to US$5,116 a tonne.

See more details of the overnight auction here.

Finance Minister Bill English said the government has lifted its estimate for the drought impact on the economy to $2 billion as dairy farmers dry off their herds earlier than usual and send livestock for slaughter in the face of stunted pasture. The kiwi dollar traded at 82.32 US cents from as high as 82.56 cents before the auction results were published.


The total volume of dairy products sold at the latest auction was 15,994 tonnes, down from 21,922 tonnes a fortnight ago and the smallest since the May 17, 2011, sale.

Westpac Bank economist Nathan Penny said the rising dairy prices had the potential to reduce (but not eliminate) the negative impact of the drought on GDP.

"Drought in the North Island is slowing milk production rapidly, forcing dairy prices upwards for now. That said, rain has been recorded in recent days, though not at levels enough to break the drought," said Penny.

"We see room for dairy prices to head up further over the first half of 2013. The tight supply conditions in New Zealand induced by drought, coupled with improving Asian growth, particularly in China, are providing significant, although temporary, upward pressure on dairy prices. As we expect the NZD to average US$0.85 over 2013 (from the US$0.83 currently), prices should also improve in NZD terms, albeit more modestly."

Penny said that with dairy prices at these levels there were upside risks to the bank's Fonterra payout forecast .

"With this in mind, we will be watching milk production data and price movements over the next few auctions closely," he said.

"In turn, any increase in the milk price component of the payout will reduce the drought impact on GDP relative to official estimates. The Minister of Finance released estimates earlier in the week, showing a drought impact of between 0.5 and 1.0 percentage points of GDP."

Penny said that estimates of milk production for the current season were of a two per cent fall.

"Despite January production data showing a 6.5 per cent year to date increase compared to the same period last year, more up-to-date estimates suggest it's all downhill from there."

In last night's auction, the price of anhydrous milk fat rose 16.3 per cent to US$4,416 a tonne and butter milk powder rose 8.6 per cent to US$3,904 a tonne. Butter rose 11.5 per cent to US$4,550 a tonne and cheddar gained 13.7 per cent to US$4,315 a tonne.

Lactose and milk protein concentrate weren't offered. Rennet casein rose 3.1 per cent to US$9,242 a tonne and skim milk powder rose 7.7 per cent to US4,050 a tonne.

There were 82 winning bidders over 17 rounds. There were 185 participating bidders out of a total number of qualified bidders of 785.

with NZ Herald