While global supply and demand slowly return to a more balanced outlook, the squeeze continues to hurt farmers in southeast Australia, which is impacting national milk production.

The October Situation and Outlook revealed decreased milk production from Australia, New Zealand and Europe is helping ease the downward pressure on global commodity pricing caused by the oversupply issue of recent years.

Dairy Australia senior analyst John Droppert said Australia's milk production was forecast to drop 5 per cent over the full season for 2016/17, as a response to low milk prices, tight margins and the ongoing impacts of flooding and excessive rain in some regions.

"The pain that many farmers in southeast Australia experienced last season, and the ongoing challenges around margins will prove significant obstacles for some processors in securing supply in the short term," Droppert said.

"Overall milk production will remain constrained in southeast states as farmers defer investment and focus on management to breakeven points, and conserving equity where margins are negative.

"The first two months of this season has seen significant year-on-year declines in national milk intakes averaging 9%, but the impact on the overall national milk volume is expected to moderate as the season progresses and the benefits of good rainfall (excluding flood and excessive rain damage) and lower costs for feed, fertiliser and water accrue for farmers across the nation."

The report also highlighted that milk production is steady or higher in Queensland and Western Australia.

Droppert said commodity markets were in a much better place than this time in 2015, but downside risks remain.

"The perennial challenge for both processors and farmers is to secure adequate milk flows to capitalise on market opportunities, while protecting against damaging price shocks. This will remain top of mind as the industry finds its feet in 2016/17," he said.

Internationally, demand is presenting a mixed picture, with China returning to growth, while other markets are more sluggish. The value of global exports fell by 19%, with falls across all major markets, largely reflecting the lower global prices for key dairy commodities.

"Total global dairy export volumes to Greater China increased nearly 20% over the 12 months to June 2016," Droppert said.

"Australia-China export volumes grew by 30%, from around 136,000 tonnes to 178,000 tonnes, while their USD value increased by over 65% year-on-year, from US$350 million in 2014/15 to US$579 million in 2015/16."

Droppert said the Australian domestic market remained characteristically steady.

"Total milk sales volumes have grown moderately, increasing by 1.5% to 1,358 million litres over the 12 months to September," he said.

"Fresh, white full cream milk sales have increased their share, up 7% in terms of volume, and 9% by value. This reflects an ongoing shift away from modified (reduced fat) milk varieties."

To view the full report visit http://www.dairyaustralia.com.au/SO.