Small towns which service the dairy sector will be the first to feel the impact of the lower milk payout, Fonterra warns.
Fonterra's Hautapu dairy factory near Cambridge - one of the towns expected to be hit by the payout drop. Photo: AFP
The payout has fallen below $5 to $4.70 per kilogram of milksolids - down from $5.30/kg.
It's the third time Fonterra has lowered its farmgate milk price since the opening forecast for the 2014/15 season of $7, announced in June.
The federation's chairman, Andrew Hoggard, said it would be midway through next year before farmers felt the impact of the reduced payout.
But Mr Hoggard said when the downturn did hit, small towns throughout the country would bear the brunt as farmers stopped spending.
"The small towns around large areas of dairy - so Ashburton, Cambridge, Matamata, Feilding - farmers basically will not be spending as much on farm infrastructure, repairs and maintenance, new equipment," he said.
"Those businesses in town won't obviously be able to spend at the other businesses in town and you'll just get that flow-on effect."
Mr Hoggard said bank managers appeared to be positive about the long-term outlook for the dairy sector and were determined to help farmers get through next season intact.
'The pain will bite'
Federated Farmers Waikato President Chris Lewis said farmers would start feeling the effects by about February once production slowed down.
"It's going to be incredibly tough and the pain will bite, not just in the rural farming area, but small towns and cities like Hamilton, they'll feel it," he said.
"The trickle-down effect will take a while but it'll be there."
Mr Lewis said farmers would cope but would need support, particularly from their banks.
Dairy growth to blame for drop
The Ministry for Primary Industries says growth in dairy production worldwide is to blame for an expected $4.2 billion drop in dairy export earnings for the year to July 2015.
The figure has been included in a mid-year update on forecasts from the ministry.
The forecast said the export industry from farming would fall from a record $38.2 billion last year to $34.6 billion - a drop of 9.5 percent.
The ministry said that reflected the $4.2 billion drop in dairy export earnings.
It said Russian trade sanctions and high inventory levels in China had hurt dairy prices.
MPI sector policy director Jarred Mair said global dairy production was growing at more than twice the rate of consumption. "So we're seeing global production of around 4.2 percent but our global consumption growth is only about 2 percent a year."
Mr Mair said higher beef prices and strong earnings in other agricultural sectors - including seafood, forestry and horticulture - would slightly offset lower dairy returns.