Higher interest rates and soft export prospects mean Australia's milk industry is unlikely to recover quickly from a slump in production which is proving even worse than had been thought.

US Department of Agriculture officials in Canberra have slashed by 370,000 tonnes, to 9.20m tonnes, their forecast for Australia's milk production in the year ending in June.

The revision, which the USDA bureau said was "somewhat unexpected" given lower feed prices and improved pasture, reflected estimates that farmers had made deeper cuts than had been thought to herds.

"Recent years have seen record high feed and irrigation water prices increase production costs, while declining world dairy prices and a stronger Australian dollar have eroded returns," the bureau said in a report.

Dairy cow numbers are expected to fall by 76,000 to 1.60m over the year.

Meanwhile productivity had been hit by "unseasonably dry conditions" earlier in the season which "slashed production to levels well below previous expectations".

Borrowing costs 

And output from Australia, which has historically vied with Argentina for third place in the world league of whole milk powder exporters, looks set to be held back by "sluggish" demand from key foreign buyers, such as Japan, as well as domestic hurdles.

Australia's central bank this month raised its main interest rate to 4.5%. Rates were 3% in October.

Heading into 2010-11, "cow numbers are expected to increase slowly and milk yields improve slightly", the report said.

The industry would work through its recovery process "over the longer term".