Forecasters expect Fonterra to pay its suppliers more than $7 a kg of milk solids this season, but say softening international markets should see dairy farmers paid closer to $6.50 in 2008-09.
The dry summer would also take some of the economic clout out of record dairy prices, with Westpac Bank senior economist Doug Steel predicting milk production this season will be 2% lower than last season, instead of 3% more as forecast.
International milk production has grown more sharply than expected, especially from the United States, and buyers were starting to resist the doubling in prices in the last 12 months, which Mr Steel said would put pressure on prices for the next two to three seasons.
Fonterra has forecast a $6.90 a kg payout for this season but Mr Steel expects the final payout, which is usually higher than the forecast, to be about $7.20 a kg.
This is despite international prices for butter, cheese and whole milk powder softening, skim milk powder falling sharply and a weak United States dollar making US milk products particularly competitive.
Mr Steel said dairy prices were not in serious decline.
‘‘There is quite a bit of room to come off but it is still profitable from a farmer's point of view. We still think $7-plus is on the table.''
Fonterra will review its forecast in April and announce next season's predicted payout in May.
Looking further out, Mr Steel forecast a $5.60 a kg payout in 2009-10, then averaging about $5 from then on.
‘‘It will certainly be better than the historical average but not as stellar as the one just finishing.''
The forecasts were bullish enough to encourage sheep farmers to continue to convert to dairying, he said.
Mr Steel said it was likely consumer resistance would see international prices continue to soften, but with just 7% of world milk production traded, prices could also be influenced by domestic milk products diverted to export markets.
New Zealand's dry summer had also made this a difficult season, and Westpac was predicting production of about 1.290 billion kg of milk solids compared with 1.316 billion produced last season.
Most of New Zealand's dairy areas have been hit by the dry summer, but especially the dairy heartlands of Waikato and Bay of Plenty.
A Bank of New Zealand confidence survey said for some farmers the dry weather would neutralise the benefits of a high payout, but in general the sector remained confident.
In contrast, the bank said sheep and beef farmers were pessimistic, with rising costs helping the short-term outlook to be described as ‘‘very bad.''
A Rabobank focus report also predicted a softening in international dairy prices, leading to a ‘‘modest fall in farm-gate prices''.
Late last year, suppliers in Australia, New Zealand, US, Argentina and Europe were being offered milk prices 40% to 60% higher than previous levels to boost supply.
The bank did not expect milk prices to fall to historic averages, although there were some risks from a global economic slowdown, Europe and the US diverting domestic milk to export products, and the outcome of Fonterra's capital restructuring.