Wellington, July 7 NZPA - Today's 13.7 percent drop in the index for Fonterra's internet auctions has shown some weakness in Oceania dairy commodity prices, a bank economist said today.

"If prices are able to be maintained at/or close to current levels, Fonterra payout is likely to be closer to $7 as opposed to $6 (per kilogram of milksolids)," said ASB rural economist James Shortall. "However, further falls in prices will be of concern."

Fonterra attributed the weaker auction results to increases in supply kicking in after a period of strong price growth: "The result reflected supply increasing globally in response to what has been a very strong price signal over recent months," said global dairy trade auction manager Paul Grave.

"Concerns in the market about short-term product availability, which to a large extent underpinned recent high prices, appear to have eased."

Other commentators have noted that inventory re-stocking is now complete in Australia -- a key customer -- and that there has been a slowing in Chinese demand growth.

The short-term supply pressures that have been supporting higher prices seemed to have eased. Prices remain well above longer-term levels and current levels for whole milk powder are 76 percent higher than in July 2009, and though today was the third consecutive monthly fall in the trade-weighted dairy index, prices remained up 61 percent in year-on-year comparisons.

Prices peaked in April 2010 at $US3969, 117 percent higher than the lowest auction price in July 2009 of $US1829.

Today, anhydrous milk fat (AMF) was down 14.1 percent on last month to $US4620/tonne, whole milkpowder (WMP) was down 14.8 percent to $US3224 /tonne and skim milkpowder was down 11.8 percent to $US3067/tonne.

The product volume sold today was significantly higher than previous months, 57,000 tonnes compared with 35,600 tonnes in June.

Goldman Sachs JBWere economist Philip Borkin said today's sale "potentially highlights downside risk" to Fonterra's forecast 2010-2011 milk price of $6.60/kg milksolids, though the new season was only in its infancy.

"We believe there are some growing headwinds for global dairy prices given waning global momentum, high intervention inventories in Europe and anecdotes of improved supply," he said.

Though the third contract offered at auction (for delivery early next year) fell to $US3100/tonne (from $US3646 -- implying "traders" expect prices to fall further), Mr Borkin said these longer term contracts had a poor track record of picking future spot prices.

Based on today's result, average dairy product prices are currently around $NZ4650/tonne.

By his firm's "rough" calculations, prices would need to average between $NZ4900 and $NZ5300 over the season for Fonterra's predicted milkprice component of $6.60/kg milksolids to be likely this season.

"Recent rains should help to ensure that NZ's milk production starts off the season on a better note compared to how the previous one ended."

How much this affected future prices remained to be seen.

"But what this is likely to reinforce ... is the current cautiousness from the farming sector."

The continuing volatility of dairy prices meant farmers would remain hesitant about spending and keen on debt reduction.

The next auction is August 4.