Banks have dropped their farmgate milk price forecasts after another disappointing drop in GlobalDairyTrade auction prices.
The headline index fell 7.9%, the third consecutive auction fall, with whole milk powder prices down 11%.
Westpac has lowered its forecast to $4.50 while ASB dropped its forecast by 40c to $4.60.
If the forecast stuck, it would leave many dairy farmers facing a second consecutive season operating with negative cashflows, Westpac senior economist Anne Boniface said.
That had the Reserve Bank ''on high alert'' for any risks that difficulties in the dairy sector posed for the wider New Zealand financial system, she said.
The forecast was still contingent on some improvement in prices over the remainder of the season and that was regarded as likely, despite the direction of recent price moves.
New Zealand dairy farmers were yet to feel the full brunt of an El Nino weather pattern, but milk production for Fonterra farmers was already running 4% behind last season and Fonterra expected it would be down 5% over the full season.
If El Nino did hit milk production, Westpac suspected it would lead to a bounce in prices, albeit a temporary one, Ms Boniface said.
The Reserve Bank had pointed out the sector was becoming increasingly stretched in the current period of low international prices, with some farmers plugging cash shortfalls by borrowing more.
Debt in the sector had already climbed by about 10% over the last year and retail banks were working with customers experiencing difficulty with an eye on the medium-term outlook, when prices were expected to recover.
But there was no escaping that higher debt levels would, in turn, probably add to farmers' costs in future seasons, she said.
Fonterra's interest-free loan offer would help, and reduce the amount borrowed from retail banks, but increasing debt was a strategy that could ''last only so long'', she said.
ASB rural economist Nathan Penny said a large hole was developing in global dairy exports, particularly for whole milk powder, with New Zealand production falling hard.
But, at this point, dairy markets and buyers were ''not too fussed''. They were well-stocked and were looking to relatively strong production from other producers to fill the hole.
''This mismatch may well continue for a period. But we see that eventually supply fundamentals will reassert over this weak market sentiment,'' Mr Penny said.
Lost New Zealand exports were too big to cover and, once markets came to that realisation, prices, particularly for whole milk powder, would correct higher.
But that might be a month or more away, he said.
ASB left its 2016-17 milk price forecast unchanged at $6.50, expecting prices to recover over this year and with the sector's overall prospects remaining positive.
