The forecasts were included in Meat & Livestock Australia's 2008 Sheep Industry Projections mid-year update, released today.

The MLA report also states that a further decline in the breeding flock, a build up in farm debt and rising costs are likely to limit the prime lamb industry's expansion over the coming five years.

MLA's chief market analyst Peter Weeks said the future of the lamb industry looks bright, however the continuation of the drought through a seventh winter and further rises in global grain prices have caused a lowering of projections for the sheep flock and supply.

"Drought, and a noticeable shift of resources from sheep to cropping, is likely to have seen the national sheep flock fall a further 6.5pc in the year to June 2008, to around 80 million head, making it the lowest Australian sheep flock since 1920," Mr Weeks said.

"Smaller declines in the flock are now anticipated, resulting in a base of around 76 million head by 2011.

"With another poor breeding season and high lamb turnoff at the end of 2007, lamb slaughter in 2008 is forecast to decline 9pc from the 2007 record to 19.2 million head, and production by 8pc, to 404,000 tonnes – still the second highest production on record."

Mr Weeks said that rising costs and debts in 2006/07 left many lamb producers in a position where they could not meet the high cost of fodder and grain required to carry lambs over into 2008.

"Hence, supply is expected to be particularly tight through this winter, leading to a high seasonal spike in lamb prices," he said.

"However, the local and global demand/supply balance for lamb continues to tighten, providing the prospect of higher lamb prices and attractive returns to lamb producers once seasons improve."

The positive price outlook, combined with stagnant wool prices, is expected to lead to a further shift within the remaining sheep flock from fine wool Merinos to dual purpose breeds and cross breeding for meat lambs.

Providing seasons improve, lamb production is still expected to expand by 13pc between 2008 and 2012, to a record 458,000t (carcase weight).