A revival in dairy prices has come to a halt with an 8.8% drop in this week's GlobalDairyTrade auction.
While an impact from the recent 1080 contamination scare could not be completely ruled out, the greater effect appeared to be a less pessimistic production outlook, ASB rural economist Nathan Penny said.
A comparison of Fonterra and competitor skim milk powder prices for a similar product showed Fonterra increased its premium and, on that basis, there was little evidence of the scare affecting prices.
Dairy markets had reassessed the New Zealand production outlook, which was now ''not that bad'', Mr Penny said.
In the weeks following Fonterra's large cut to its production forecast and the official drought declaration, markets feared the worst.
''Subsequently over February, markets bid up prices aggressively in anticipation of New Zealand milk being scarce on the ground. Now, they've had a change of heart,'' he said.
Rain had fallen in many parts of New Zealand, easing the fears around the worst effects of the drought, and while production growth continued to slow, it was ''not falling off a cliff''.
Fonterra had also increased auction volumes and its forecast annual auction supply, while flat nationwide production growth was expected for the season.
The bank saw this week's result as a correction in the market's earlier overreaction and believed the upward price trend remained intact.
Key whole milk powder fell 9.6% but that decline followed jumps of 19.2% and 13.7% in the February auctions.
Casein and butter milk powder both recorded double-digit falls while all other products recorded falls of between 5% and 10%.
Westpac had downgraded its forecasts of Fonterra's farmgate milk price for both this season and next season, largely to account for the reduction in the ''drought premium'', economist Michael Gordon said.
The timing of the fall in prices meant it mattered ''much more'' for next season's payout for this season.
Westpac has shaved 10c off this season's forecast, down to $4.90, which was still higher than Westpac's $4.70 forecast, and 30c off next season's, down to $6.10.
A smaller-than-expected hit to milk production also meant there should be a smaller profile for GDP over the next year or so, Mr Gordon said.
Previously, the bank was expecting GDP growth to slow to 0.4% in the March quarter, now it expected it to be closer to 0.6%.
The subsequent boost to GDP growth towards the end of this year, as milk production returned to normal levels, would be smaller as a result.
