More pressure on milk payout

Some economists predict Fonterra’s farmgate milk price could go as low as $3.50 a kg. Photo / Alan Gibson

Market expects Reserve Bank to cut interest rates twice this year to partly compensate.

Whole milk powder prices have dropped to their lowest level since 2008, putting more downward pressure on Fonterra's farmgate milk price forecast and reinforcing the market view that the Reserve Bank will cut interest rates twice this year to partly compensate.

At yesterday's auction, the GlobalDairyTrade index dropped by 9.3 per cent to post its tenth consecutive decline since March. Whole milk powder prices - which largely determine Fonterra's farmgate milk price - dropped by 10.3 per cent to US$1590 a tonne.

The price of skim milk powder - a key product for the country's second biggest dairy co-op, Westland Milk - dropped by 14.4 per cent to US$1419 a tonne.

At US$1590 a tonne, whole milk prices were well short of the US$3500 a tonne needed to make the $5.25 per kg of milksolids forecast a reality.

Chief executive Theo Spierings and chairman John Wilson are expected to release a downwardly revised forecast tomorrow and some economists predict the milk price could go as low as $3.50 a kg.

ASB Bank senior economist Jane Turner said the auction highlighted the risks to the economy brought on by dairy - the country's biggest export. "A substantial amount of dairy sector weakness has already been factored in to both our own and the Reserve Bank's forecasts," Turner said.

ASB expects the dairy market will soon start to stabilise.

"But if we don't see that happening, there are certainly downside risks and a growing case for further interest rate action," she said.

Economists generally expect to see two more official interest rate cuts of 25 basis points each by October, which would take the rate down to 2.5 per cent.

ANZ said the signs were not looking good for tomorrow's forecast for Fonterra. "It would not surprise to see prices fall further in the coming weeks and months given the US Department of Agriculture's expectation that global milk production will be a record 580 million metric tonnes in 2015," said Nigel Brunel, director financial markets at OM Financial.

ANZ said the auction was "about as bad as it could have been".

Since March 4, the cumulative fall in average dairy prices has been 46 per cent, taking the level of dairy prices below global financial crisis troughs and to around 12-year lows.

The volumes sold on the GDT portal were significantly up, with 46,527 metric tonnes sold, the highest since last October.

"Given that the next seven auctions account for a significant chunk of annual [GlobalDairyTrade whole milk powder] sales, it doesn't take a rocket scientist to work out that auction prices of the next two months will weigh heavily on the final milk price outcome for the 2015/16 season," ANZ said.

The price fall, together with the 3.7 per cent fall in non-dairy commodity prices revealed in this week's ANZ commodity price index, suggested the country was in for a terms of trade hit.

Brian Rice, owner of Chicago-based commodities broking house Rice Dairy, said the GDT result showed that Fonterra's milk price might struggle to get over $3.00/kg.

"It is not pretty for the global dairy trade and not pretty for New Zealand farmers," Rice told the Herald. "We are close to the bottom but I don't think we are quite there yet."