There is a renewed sense of optimism among dairy farmers - but many are still threatening to leave the industry if prices fall.

So claims a report by levy board DairyCo, which has revealed that the number of farmers intending to leave the sector in the next two years has fallen to 7% this year from 17% in 2007 as a result of improved prices. In 2004 26% of farmers said they planned to exit the sector.

The number of farmers planning to increase production has risen from 20% last year to 37% this year. Many of these are young owner-occupiers who have a dairy-only farm with production of more than 1.5 million litres per year.

The survey also examined farmer sensitivities, asking producers how they would respond to specific market changes.

It showed that 30% of farmers would quit the industry if the milk price dropped by 2ppl, and 65% would leave if it fell by 4ppl.

The latter scenario would reduce British milk production to about 5.2 billion litres per annum, less than half the predicted production for 2009/10 of slightly more than 11 billion litres.

The figures showed recent structural and supply chain changes in the dairy market had improved trading conditions for most dairy farmers, said Dairy UK director general Jim Begg.

"However, for UK milk production to fully stabilise, farmers need the confidence to undertake major investment, allowing them to achieve production efficiencies while meeting a growing burden of regulatory costs," he said.

"It is therefore important the maximum value is obtained from milk. The recent rise in farmgate prices has seen it recover the ground lost over the past 10 years, and sterling's devaluation will underpin these gains."

With milk in short supply farmers should take advantage of being in a stronger negotiating position, added NFU dairy board chairman Gwyn Jones.