It has been the standard retort of processors to dairy farmers' complaints about low prices that falling commodity values dictate the price of raw milk. In response, UK dairy farmers have warned that falling milk prices combined with higher production costs would slash milk output. They have even claimed the UK dairy industry would jeopardise supplies of fresh milk and added-value dairy products. Milk production has been falling steadily since 2003, dropping a further 1% in the most recent milk quota year to March, reinforcing that claim. And if a recent Milk Development Council survey, which suggests that 16% of dairy farmers are planning to quit over the next two years, holds true, the situation will get worse. However, there are signs that the endless cycle of deflation in farmgate milk prices may be coming to an end. This is due, in part, to Tesco's well-publicised initiative to set up a dedicated milk pool and pay its farmer suppliers about 20% more than they get at present. This seems likely to be mirrored by other major retailers and could raise farmgate milk prices for those involved from the current average of 18ppl to about 22p. Even if this price revolution sweeps through the liquid milk market, about half of UK milk output will still take prices based on returns from cheese, butter and milk powders. Over the past year, milk supplied for these markets has been earning as little as 16p to 17p per litre for the farmers concerned. But there are signs of an improvement here as well. Due to a worldwide shortage of dairy products caused by rising consumption and falling milk output, market prices for butter and milk powders have escalated to an unprecedented degree. On world markets, butter prices are up by 26% since January and milk powder prices are up by nearly 40%. In the UK and EU, butter prices so far this year are up by 11% and milk powders by between 16% and 27%. So price increases for farmers whose milk goes into these products should soon be on the way. Only the price of milk used in cheese, which accounts for 30% of UK milk production, has remained static. This poses the risk that the range of milk prices could become impossibly wide, say from 16ppl to 22ppl. And if cheese prices remain static then many farmers will either still get a poor milk price or cheese manufacturers will be forced into switching their milk to better markets. The implication is that cheese prices will have to rise sooner or later this year. Michael Bessey

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