A recent surge in milk prices has further upside, especially as sweltering U.S. weather curbs production, diary traders and analysts say.

Class III milk futures traded in Chicago, which reflect an industry benchmark, have jumped over 9 percent over the past three weeks, reaching the highest level in more than four months today.

A heat wave gripping the Midwest and Northeast U.S. has fueled bullish sentiment because cows typically produce less milk when temperatures are high.

Chicago milk futures are “on an upward track over the next month or so,” said Eric Meyer, a broker with Downes-O’Neill/FCStone in Chicago. Prices have potential to climb another 50 cents to $1 per hundredweight, he said.

In today’s trading, Class III milk futures for August delivery rose 25 cents to $14.78 per hundredweight, up from a life-of-contract low of $13.57 on June 22. July futures rose 13 cents to $13.77, the highest settlement for a closest-to-expiration contract since early March.

Temperatures rose above 90 degrees Fahrenheit in major dairy regions of the Midwest and Northeast in recent weeks, and hot weather is expected to continue this week.

In Madison, Wis., for example, highs are expected to reach 88 degrees Wednesday and 86 on Friday, Saturday and Sunday, according to the Weather Channel’s Website.

Ten-day forecasts for much of the country predict temperatures from the mid-80s to mid-90s, Meyer and colleague Dave Kurzawksi said in a report today.

“Humidity levels in the Midwest are on the rise and this will continue to impact milk production levels in a negative way,” Meyer and Kurzawski said.

“Moreover, we are approaching the time of year that milk production is seasonally at its low point and milk product demand tends to be at its highest over the next four to six weeks,” they said.

Also, “inventories of dairy products seasonally decline during the third quarter and end-users tend to begin their hedging programs around this time as well, keeping a relative floor underneath futures prices,” the brokers said.

Other factors have also fueled renewed bullishness in the dairy market outlook after milk prices slumped this spring when it became clear U.S. production was on the way up again after declining in 2009.

The USDA, in a July 9 report, raised its milk price forecast for 2011. Class III prices are expected to average $14.40 to $15.40 per hundredweight next year, up from a previous estimate of $14.35 to $15.35.

Prices are creeping higher at the retail level, with fresh, whole milk averaging $3.18 a gallon nationwide in May, up 4 cents from April, according to government data.

Block cheese traded in Chicago has also rallied, reaching a high for the year July 9 at $1.5275 per pound, reflecting tighter supplies and strong demand.

Over the next few weeks, cheese may reach the mid-$1.60s if butter prices remain high and heat persists, Meyer said.

But high cheese supplies may temper price upside, Meyer added. He also cautioned that the milk price rally probably is “a bit short-term in nature,” citing market fundamentals such as rising U.S. production.

Dairy producers should use the recent rally “as an opportunity to lock in floor prices underneath the market for the remainder of the year,” Meyer said.