Iron ore has continued its downward plunge as waning demand in China and increased production from the world's largest miners, continues to weigh on the steel-making ingredient.

The price of iron ore, for immediate delivery at the port of Qingdao in China, slumped another 2.6 per cent overnight to $US55.48 – the lowest price since the index began in 2009. Iron ore has fallen nearly 4 per cent this week.

The falls come as the Australian government downgraded its 2015 iron ore forecast by 5 per cent to $US60 ($76.80) a tonne on Wednesday, punching a $1.8 billion hole in the federal budget's bottom line.

Chinese demand has further softened while large miners such as BHP Billiton, Rio Tinto and Vale have added to a supply glut by ramping up production.

A psychological bias that leaves analysts preoccupied with the recent past, has led to dangerously optimistic forecasts about the iron ore price, fund manager Auscap said.

Auscap co-founder and investment manager Tim Carleton, said many analysts acknowledged the deteriorating market conditions and yet predicted prices would be higher in the medium term.

FORECASTS 'FRAUGHT WITH DANGER'

In a recent newsletter, Auscap warned that based on current supply and demand facts, forecasting a higher-than-spot iron ore price "appears fraught with danger".

Mr Carleton said analysts predicting a near-term return to $US60-$US70 could still "feel bearish" because those prices remained low in terms of the commodity's recent history. Iron ore fetched almost $US120 less than a year ago and above $US190 a tonne four years ago.

Mr Carleton said the disparity between the worsening fundamentals of the iron ore market and relatively optimistic price prediction could be explained by an "anchoring effect".

"In other words, investors are influenced in their investment decisions by the recent price history of a particular security, even if this price history has no significance in estimating the company's current worth," Mr Carleton wrote in a letter to investors.

It is that dynamic that Mr Carleton believes is at play in the iron ore market as analysts and investors use a once in a generation commodity boom as a meaningful reference point for future prices.

ANZ commodity strategist Daniel Hynes agreed some of the market's rosier forecasts could be put down to an anchoring effect.

EXPECTATIONS CLOUDED

"It wasn't that long ago that we were at $US100 a tonne so the impact of that can certainly cloud expectations going forward," he said.

"When you look at it on a historical level, it's still a relatively high price."

Mr Hynes said the market would likely adjust to a "new normal", stabilising as supply growth subsided and Chinese steel production recovered. He expected the commodity to trough at about $US55 a tonne, ANZ's end-of-June-quarter forecast.

The Australian Department of Industry's downgrade of the iron ore forecast on Wednesday came three months after it drastically revised the price to $US63 from $US90 – still above where iron ore is currently trading.

"Throughout most of the past 12 months, iron ore producers have engaged in constant price cutting to move their production volumes in an increasingly competitive environment, with some producers already operating at a loss," the department said.

Large Australian miners such as BHP Billiton and Rio Tinto have cut costs in order to keep producing high volumes of iron ore at a profit.

Meanwhile, China's hunger for steel has further faded. The country's growth target stands at 7 per cent, the lowest in more than 15 years. House prices have declined, fewer houses are being built and steel remains in oversupply.