The grim news came as Prime Minister John Howard toured drought-affected areas in regional NSW conceding increased prices could add to inflation which would put pressure on interest rates.
Mr Howard said that the effects of six years of below average rainfall would have some impact on prices.
"It's already starting to have some impact," he said, warning that an expected interest rate rise next month may be necessary to contain a bigger increase in prices in the future.
His comments came as the nation's top commodities forecaster, the Australian Bureau of Agricultural and Resource Economics, released revised crop production figures for 2006/07 as the impact of the drought becomes clearer.
The bureau predicts wheat growers will face their smallest crop since 1994/95 as their harvest falls to 9.5 million tonnes this financial year.
Their forecast harvest is nearly one third the size of the 2005/06 crop of 25 million tonnes.
Production of barley and canola is also tipped to suffer. The bureau says the barley crop is forecast to be 3.6 million tonnes this financial year, down 64 per cent on a year ago, while canola is tipped to fall to 440,000 tonnes, 69 per cent lower.
According to the Prime Minister the worsening drought will hurt farm production, add to inflationary pressures but will not have a major impact on overall economic growth.