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Dairy farmers' incomes could drop by more than $4 billion this season after Fonterra yesterday slashed its milk price forecast from $7 to $6.
The dairy giant also announced an estimated dividend range of 20c-25c per share, amounting to a forecast cash payout of $6.20-$6.25.
While there was an expectation that Fonterra would reduce its forecast milk price, the announcement was lower than most in the market were expecting and would come as a shock to farmers, Westpac chief economist Dominick Stephens said.
International dairy prices have continued to fall sharply since Fonterra announced its $7 opening forecast in May, with the GlobalDairyTrade index declining 16% since the start of the season on June 1.
Prices have been affected by strong global production, softer demand, inventory build-up in China with its slowing economy.
A drop in the milk price from $8.40 to $6 this season would amount to a reduction in the collective income of dairy farmers of about $4.3 billion, or 1.9% of GDP, Westpac said.
The New Zealand dollar fell US0.2c immediately after the announcement and the forecast was ''one more reason'' to expect further downward pressure on it, Mr Stephens said.
Westpac expected the dollar to drop to US84c in the weeks ahead and it was forecasting an average exchange rate of US83c over the remainder of the year.
At this stage of the season, the final payout remained ''very uncertain'' and much would hinge on how GlobalDairyTrade auctions evolved over the few months ahead.
Westpac was assuming a small further reduction in auction prices over the next ''month or two''.
A ''very substantial'' recovery in prices was expected but not until the last quarter of the year, he said.
Fonterra chairman John Wilson said the drop in the forecast milk price would have an impact on farmers' cash flows.
''We continue to urge caution with on-farm budgets in light of the continuing volatility in international dairy markets,'' Mr Wilson said.
Earlier this month, Federated Farmers dairy chairman Andrew Hoggard said a $6 payout was the practical break-even for about 20% of the industry with high production costs.
Fonterra chief executive Theo Spierings said some recovery in global dairy prices was forecast but it was too early to predict when, or how big in might be.
As Fonterra continued to drive for growth in its consumer and food service businesses, during the first half of the current financial year it expected reduced cost of goods arising from lower dairy commodity prices to have a positive effect on returns, Mr Spierings said.
''It is important to note that in light of the significant volatility, our dividend estimate is based on zero ingredients stream returns at this early stage in the season,'' he said.
The dividend expectation had been lifted from an indicated 10c for the 2013-14 season.
ASB had been anticipating some rise in the dividend given the shift to a more favourable mix of higher cheese and casein prices relative to milk powders.
The reduction in milk prices also reduced input costs for the value-add businesses, chief economist Nick Tuffley said.
Dairy farmers' confidence moved into negative territory in Federated Farmers recent new-season confidence survey.
They experienced a massive 87-point fall in profit expectations, going from being very optimistic to very pessimistic in the space of six months.