International milk prices fell for the first time in three months while volumes dropped in Fonterra Co-operative Group's latest auction, renewing the threat to farmer incomes and sending the New Zealand dollar lower.

Fonterra's GDT Price Index dipped 8.8 percent, with an average selling price of $3,136 per tonne, in the auction held on Tuesday. The result was the first decline since mid-December, and the biggest fall since mid-July last year.

"On the surface, it appears now that markets have factored a less pessimistic New Zealand production outlook and bid down prices," said Nathan Penny, rural economist at ASB.

Dry weather and weak prices have seen farmers trim production. Fonterra has forecast a 3.3 percent fall in output, as well as cutting the volumes being offered for sale in the auctions.

Prices for the key wholemilk powder product, which underpins Fonterra's forecast payout to its suppliers of NZ$4.70 a kilogram, fell 9.6 percent after hefty rises in the previous two auctions.

ASB's Penny said it appeared that Fonterra, the world's largest dairy exporter with brands such as Anchor, Anlene and Fresh n' Fruity, had largely escaped any market backlash over the threat to poison infant formula and other products which was disclosed last week.

"A comparison of Fonterra and competitor ... prices for a similar product showed that Fonterra actually increased its premium. On this basis, there is little evidence of the contamination scare impacting prices," Penny said.

A total of 20,258 tonnes was sold at the latest auction, falling 8.3 percent from the previous one, the cooperative said on the auction website (www.globaldairytrade.info).

The auctions are held twice a month, with the next one scheduled for April 1. The New Zealand dollar fell to a five-day low to around $0.7310 from $0.7350.

The New Zealand milk co-operative, which is owned by about 10,500 farmers, controls nearly a third of the world dairy trade. Dairy products account for more than a quarter of New Zealand's export earnings and the sector generates more than 7 percent of the nation's gross domestic product.

(Bengaluru Commodities desk and Gyles Beckford; Editing by Alan Crosby)