Dairy market outlook

February 2023

• GB milk production is forecast to record marginal growth in 2023 in the region of 0.3%. However, there is some risk of a contraction in production if margins deteriorate.
• Despite some recent signs of lower inflation in agricultural input costs, replacement costs through 2023 will remain high, putting pressure on cash flows.
• Global dairy demand is likely to remain challenged by low economic growth, although there is potential for improved import demand from China later in the year.
• Domestic demand is also expected to be impacted by a squeeze on consumer incomes, with all products seeing lower sales.
• Farmgate prices are expected to decline in the first half of 2023, with some potential for this to abate in the second half if inflation subsides and demand recovers.

Domestic milk production

GB milk production is forecast to reach 12.44bn litres for the 2022/23 season, up 0.7% on the previous season, according to the December forecast update. On a calendar year basis, GB production is expected to total 12.43bn litres. This is a 0.3% improvement on 2022, equivalent to an additional 39m litres.

Deliveries since October have been above previously expected levels, boosted by the favourable weather conditions, and high milk prices. In the four months from October to January[1], deliveries were 3% ahead of year earlier levels when production had been subdued by rising costs and concern over margins.

Before this, GB production had been running below year-ago figures since July 2021, although the year on year growth recorded in March through June was more to do with the sharp enforced reductions in the spring of 2020. An unfavourable milk-to-feed-price ratio, driven by rising feed costs and stagnant farmgate prices, was the key driver of lower yields in the autumn of 2021, although labour shortages will also have played a role. Margin pressures then worsened as global energy prices spiked, with the situation exacerbated by the outbreak of the war in Ukraine. The increase in milk prices through 2022 helped to offset the rising costs and supported improved yields in the final months of the year.

The uplift in production from Sep-22 onwards, and the expectation that yields will remain supported as we move towards the 2023 spring flush, shifted the December forecast for the 2022/23 season from an expectation of further contraction (-0.8%) into growth (+0.7%).

As we move into the final quarter of the current season (Jan-Mar), our yield expectations become more tempered, moving back below the strong growth rates seen in recent months, and more in line with longer term trends.

Decreasing farmgate milk prices, labour shortages, and rising interest rates, combined with the continued burden of high input costs on working capital requirements, are expected to limit further yield growth through 2023.

GB production is projected to record growth of 1.2% in the first half of the year, but then fall back by 0.6% in the second half of the year. This is in part due to the high comparable figures in 2022, but also as a result of reduced yield growth. Currently, milk prices are, on average, sufficient to cover increased production costs, but should this balance shift and costs outweigh prices, milk supplies in the second half of the year could fall by a larger amount.

In contrast to the volatility seen in yields as farmers reacted to cost pressures and forage shortages, the GB milking herd has remained relatively stable. The long-term trend of gradual decline continues – though the latest data showed the smallest annual contraction in the October herd since 2017. Overall, the number of cows in the milking herd at the time of the December forecast was marginally up on the previous projection, contributing slightly to the lift in forecasted volumes– but this had a minor impact compared to changes in yields.

[1] January volumes are estimated as data was only available to 28 January at time of publication.

Global milk production

 According to the latest delivery data for the key milk producing regions[1], global production returned to growth in September 2022 after 12 consecutive months of declines. Recovery in production in European countries, combined with growth in the US, was at the centre of the turnaround as southern hemisphere regions continue to record year on year drops.

Despite the recent upturn, total production across the key regions in the year to date (Jan-Nov22[2]) was 0.5% lower than the previous year. Early forecasts for 2023 suggest no growth, although that varies by region. Higher production in the US (+1%) will be offset by reductions in most regions with the exception of a small gain in the UK (+0.3%) and unchanged production in Australia.

Most of the growth looks set to occur in the first half of 2023, which is forecast to see an increase of 0.8% (1.1bn litres). This is driven by higher milk deliveries through the flush months in the northern hemisphere.

[1] US, EU-27, UK, New Zealand, Australia, and Argentina; forecasts from Dec22

[2] EU-27 data for December is not yet available

Product availability

With less milk available in almost all major producing regions this year, production of most dairy products was down year on year. Despite a small increase in milk production in the US, higher exports kept stocks from building up. In the EU, exports were down for the most part, impacted by uncompetitive pricing, which helped to offset the reduced production. According to the latest data[1], there has been little change in availability for butter, cheese or whole milk powders in the EU-27, while SMP availability had improved, mostly due to weak exports.

The situation is similar in the UK. Here, despite higher production volumes of cheese, exports increased year on year, tightening availability relative to the previous year. Butter availability is unchanged year on year, while milk powders saw a small increase due to the drop-off in both production and exports.

While there doesn’t appear to be an excess of stocks overhanging the market, sentiment has shifted as milk supplies improved in the final quarter of 2022, and are expected to increase further as we move into the northern hemisphere flush. Wholesale markets, both domestically and globally, have been weakening as production has been improving, with the monthly reductions accelerating in recent months.

[1] Data is available on product production to Oct22

Pricing expectations

Demand is expected to remain weak through 2023 as economic growth remains subdued and consumers grapple with higher living costs. Combined with the increasing availability of milk, stocks are expected to build, keeping markets under pressure. However, lower prices should bring price-sensitive importers back to the market, helping to slow the decline. The latest forecasts for import demand from the USDA, published in December 2022, reflect this.

However, these projections did not account for the shift in China’s policy towards Covid. In light of the relaxation of it’s zero-tolerance policy, there is now an expectation that demand will pick up – although the timing of this is still unclear. According to the latest Rabobank outlook, China may start to increase import buying by the second half of 2023. This is dependent on the recovery of the hospitality and tourism sectors, and the absence of any fresh Covid outbreaks.

Impact on farmgate prices

GB farmgate prices rose significantly through 2022, although increases slowed in the final quarter as markets weakened. The annual average milk price in GB is expected to be in the region of 46ppl for the 2022/23 season, taking into account announced price cuts to Mar-23. This compares to an average of 33ppl in the previous season.

Increases in milk prices through 2022 were pushed through faster than under normal circumstances, triggered by the unprecedented rise in farm input costs and the threat of milk shortages. On average, annual production costs[1] increased by 12.5% in the 12 months to Nov-22. However, the year-on-year increase in the average cost of key inputs such as purchased concentrates, fertiliser and fuel[2] were much larger at 33%, 98% and 59% respectively.

While the rapid rise in input costs will have played a part in pushing up milk prices, strong returns from the market in the first part of the year supported the additional cost to processors. In addition, selling prices into retailers will have increased, with potential shortages and high supply chain costs allowing for re-negotiated prices.

However, the value of dairy products has been weakening since last autumn, impacting on processors' ability to maintain the elevated milk prices. Added to that, it’s likely processors found it increasingly difficult to pass higher costs into consumer prices in the latter part of the year with demand showing signs of pressure. In 2022, the retail price index rose by 13%, with most of the inflation occurring in the second half of the year. Dairy product prices[3] rose by over 30% in the year, with fresh milk seeing the highest rate of inflation.

The combination of rising milk production and a declining market suggests milk prices will come under pressure in the first half of 2023. With production costs expected to remain at elevated levels through the year, milk production could contract if milk prices fall to unprofitable levels. This could serve to slow, or stabilise, the drop in milk prices in the second half of 2023 if demand is not hit too hard. The timing of China’s return to the market will play a big role in when we can expect prices to stabilise.

Our current projections for domestic demand expect retail sales of cheese, butter and yoghurt to fall by around 3% in 2023. Liquid milk sales are expected to revert to the long-term trend of a 1% annual decline (see full analysis below).

[1] Based on full economic production costs, which include a value for unpaid family labour, depreciation and an imputed rental value for owned land. They reflect on-farm costs rather than spot prices of inputs.

[2] Based on published Agricultural Price index values for compound feedstuffs for cattle, straight fertilisers (nitrogenous) and fuel (for heating)

[3] The fresh milk retail price index rose by 38%, butter by 29% and cheese by 31% in 2022.

The extraordinary inflationary pressures facing consumers through 2022 put a strain on shoppers’ budgets. This resulted in the majority of consumers claiming to be spending less on the weekly food shop and eating out. In terms of retail sales, all products saw lower volume sales, although the revenues were up.

The continued strain on shoppers’ budgets is going to have the biggest impact on behaviours going forward, with the UK predicted to be in recession in 2023 and inflationary pressures are expected to continue.

Dairy retail sales may benefit from some shoppers moving their out-of-home spend in-home. However, while there will be more in-home consumption occasions, shoppers are very much scaling back on volume. This includes reducing food waste, utilising all leftover product in order to reduce the amount they need to purchase on a regular basis.

Cost will be a key influence on volume reduction, with 27% of those who are looking to cut back on their dairy consumption because of the cost (AHDB/YouGov Consumer Tracker, November 2022). Indeed almost 6 in 10 consumers (57%) claim that the price has become more important to them when buying dairy. Health and environmental concerns are still very much present and should be expected to return to focus later in the year and into 2024.

Milk:

Coffee shops are expected to be further impacted by the cost-of-living crisis, which could result in more in-home hot drinks. This could benefit retail sales of milk, however we expect shoppers to reduce the volume they purchase and also waste less milk. In addition to this, despite the higher price point of alternatives, they are currently outperforming cow’s milk, potentially indicating new habits linked to the greater availability of these products. This means that for 2023 we expect milk volumes through retail to be down by 1% year on year and, compared to 2019, this results in a 2% decline in volume.

Cheese:

The cost-of-living crisis is likely to drive up the number of lunchbox occasions that could help the fortunes of cheese. However, there will be continued trading down in order to save money (for example from extra mature to mature cheddar) as well as a reduction in varieties purchased. This means that territorials are likely to suffer more than everyday cheeses, such as cheddar. Cooking/ingredient cheeses, such as halloumi, paneer, mozzarella and feta, could outperform the rest of the category as consumers look to substitute meat as a main meal component. We expect cheese volumes to decline by 3% year on year, representing a 4% increase on 2019.

Butter:

An anticipated increase in the number of in-home lunch and breakfast occasions could provide opportunities for butter in sandwiches and on toast. However, the price gap between butter and margarine has increased and there is also heightened consumer awareness of the price of butter due to previous media coverage. We expect this to result in shoppers switching from butter and dairy spreads into margarine and alternatives. In the last recession, baking boomed as people sought out more affordable leisure activities. Whilst this could be replicated in 2023, butter is still seen as substitutable in baking occasions, and it will therefore need to fight to remain relevant. As a result, we expect butter retail volumes in 2023 to be down 3%, however this would still result in category volumes being 3% higher than in 2019.

Yogurt:

Consumers are simplifying their meals and cutting back on extra consumption occasions such as desserts, which could put pressure on yogurt volumes. In addition to this, health is a key driver of yogurt consumption but in 2023 health will become less of a priority as consumers seek out more affordable treats. We expect retail volumes of yogurt to be down by 3% year on year, representing a decline of 5% compared to 2019.

There remain opportunities for growth however, by focussing on the attributes of dairy which remain linked to consumer priorities.

• As consumers feel the economic pinch, encourage dairy consumption in lunch boxes (cheese, butter, and yogurt) for those cutting back on their out-of-home consumption, while also providing recipe inspiration for quick home-made lunches that include dairy for those who continue to work from home.
• Highlight dairy as an affordable source of nutrition, addressing consumers’ need for value while supporting the long-term health perception of dairy. This could include promoting dairy as a cost-effective source of calcium and vitamin B12.
• There is a need to reassure consumers who may be turning to dairy alternatives about the health, environmental and welfare credentials of dairy.
• In the longer term, look to maintain and build consumer trust, demonstrating where farming values (animal welfare, environmental stewardship and expertise) are shared with consumers. See our consumer reputation landscape hub for more information.

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