The tightness in dairy supplies, which on Tuesday lifted prices at a key auction to their highest since 2007, will continue for most of the year, raising the prospect of values "holding firm", Rabobank said.

In a report published hours after a scramble for dairy products sent prices soaring at GlobalDairyTrade, lifting gains this year to 38%, the bank said that "the balance of evidence appears to support the case for international prices holding firm for at least six months".

The drought in New Zealand, the world's biggest dairy exporting country, which has been central to the price rally will see monthly output fall 15-20% below year ago levels.

New Zealand milk production, while in January recording its 25th successive month of year-on-year increases, "has been falling below prior-year levels since February by an increasing margin with each week that passes", Rabobank said.

Even assuming a recovery in pasture condition, elevated costs and tightening environmental legislation on slurry will limit output growth to less than 2% in the second half of 2013, when output will ramp up from a seasonal low over the next few months.

Output declines

And the big northern hemisphere producers, approaching their spring flush in output, look in poor shape to lift their own milk volumes for now.

In the US, poor margins for farmers in many key areas will "keep production below prior-year levels in the first half of 2013", by some 0.4% year on year, Rabobank said.

Many major US dairy producers are situated in western areas, such as California, to where the costs of bringing in feed from arable regions, such as the Midwest, are adding to the dent to margins from elevated grain prices.

In the European Union, where Dutch co-operative FrieslandCampina last week forecast a decline in first-half output, production will fall 0.7% in the first six months of the year, "due to tight margins and a lack of quality feed until spring is well underway".

Chinese 'explosion'

With as poor finish to the southern hemisphere season, which has also seen Argentine output slump 26% in the November-to-January period, coinciding with a soft start to that in the northern hemisphere, "total milk production in export regions will fall below prior-year levels in the first half of the year".

An "explosion" in Chinese imports, which soared 68% in January and has been a big support to price rises, "will ease back, with an unusually large degree of forward buying assumed to have taken place in recent months," Rabobank said.

"But other buyers will likely take up the slack.

"The quest for additional supply should ensure a tight global market environment in the second and third quarters, before a new southern hemisphere season and an easing in global feed prices enable the market to balance at somewhat lower prices in the fourth quarter."

'Rebalancing of prices'

The bank also forecast that a sharp divergence in prices between different dairy products "should slowly abate as 2013 progresses".

Whole milk powder prices proved particularly strong at GlobalDairyTrade, soaring 21% to an all-time high, and opening up a 26% premium over skim milk powder.

Skim milk powder was the more expensive from November to January, although this position is unusual, given that it lacks the fat element stripped out and sold separately, and was attributed to strong demand from China, which has little capacity for making the product itself.

"A rebalancing of prices… is expected in the coming months as sellers reallocate milk to higher return product lines and buyers seek out discounted product," Rabobank said.