The Reserve Bank expects whole milk powder prices to rise by about 44 percent next year as the slump in global prices this year prompts less competitive processors to scale back their production in the face of smaller returns.

The central bank expects whole milk powder, which is New Zealand's dominant dairy export, to rise to US$3,200 a metric tonne by early 2016, from its current price of US$2,229/tonne as international producers who were lured by record prices last year are squeezed out by this year's decline, governor Graeme Wheeler told Parliament's finance and expenditure select committee after this morning's monetary policy statement.

New Zealand's advantage is that it's the most competitive dairy producer in the world and can operate with lower prices than its rivals, he said.

"If you've got a price that's somewhere around US$2,200/tonne and you think equilibrium or the market clearing price is something like US$3,200 to US$3,800, a lot of people are losing money below that price so the market will clear," Wheeler said. "The issue is when it will clear, and that's something that we all as a country have got to look at very carefully."

Fonterra Cooperative Group, the world's biggest dairy exporter, this week cut its forecast payout to farmers by 60 cents to $4.70 per kilogram of milk solids after prices halved from a peak in February. Chief executive Theo Spierings had said the previous forecast of $5.30/kgMS was predicated on the whole milk powder price recovering to US$3,500/tonne by early next year, and the weaker price at last week's auction prompted the futures market to predict a more modest recovery in price.

Bank economists estimate the lower forecast payout will cut the dairy sector's income by more than $6 billion from last year when prices were at a record, and the RBNZ's Wheeler told politicians if the dairy price didn't recover that would have a "significant impact on the economy."

Wheeler said farmers had used last year's high payout to repay debt, build up cash reserves and improve their farms, and that they hadn't been wasteful in their spending.

"We'll start to see the real pressure going on later next year," he said. "Let's say that price stayed very depressed, the difficult situation would be that farmers were not only cash constrained and income constrained, but also if land prices started to fall at the same time. That would not be a good scenario at all."

Last month, deputy governor Grant Spencer told the same select committee that dairy farmers had strong enough balance sheets to cope with one poor season, but may come under more duress if a low payout persisted for two or three seasons.