Westpac is warning that the country's milk production could drop for the first time in five years if drought conditions in the North Island continue.

The bank's agri-economist, Nathan Penny, said milk production for the 2012-2013 season may fall by as much as 2 per cent, despite growing herd sizes and a bumper spring.

As recently as last month the bank was still expecting total production to be up slightly from last year, but the drought had since pushed production levels "off a cliff".

The entire North Island was declared a drought zone last week, and parts of the mainland also remain very dry.

"Our best case scenario is now for this season's production to equal last year," said Penny.

"It all depends on when the rains come."

Westpac agribusiness head David Jones warned that the full financial effects of the drought may still be several months away .

He said many farmers were still in a fairly strong cash position after moving quickly to shed stock.

"However, with the killing chains now at full capacity, uncertainty over feed supplies, and a likely shortage of replacement stock, a lot of their issues are still ahead of them," said Jones.

The warning comes after prices at Fonterra's latest online dairy auction reached record highs overnight.

The GlobalDairyTrade TWI Price Index surged a massive 14.8 per cent compared with the last sale two weeks ago, marking the seventh straight gain for the basket of dairy products. It now sits at its highest point since December 2007. 

The average winning price at the auction rose to US$4683 ($5685) per metric tonne, up from US$4216.

Maximum supply, or the measure of how much dairy product Fonterra has for sale, was just 16,320 tonnes with a total of 15,994 tonnes sold. That volume has halved in the space of a month. 

At last night's auction, seven of the nine product categories rose, and two weren't traded. 

Whole milk powder, the largest product category by volume, rose 21.2 per cent. The next biggest gainer was anhydrous milk fat, up 16.3 per cent. 

Lactose and milk protein concentrate were not traded. 

The auction saw 185 participants out of 785 qualified bidders take part, with 82 winning bids. 

The dairy industry is the country's biggest export earner.

- © Fairfax NZ News