Quarterly inflation came in at 0.4%, below the market forecast of 0.7%, which was also the forecast by the central bank.
More importantly, annual inflation fell to 4.6% from a 21-year high of 5.3%.
Financial markets reacted quickly to the surprise as they had been positioned for a 0.7% result. The New Zealand dollar fell 40 points to US80.4c and the two-year swap rate fell 0.6%.
Westpac chief economist Dominick Stephens said the main surprises were some substantial price drops because of greater competition in several industries. While that was not a bad thing, it was not necessarily something that would be seen on an ongoing basis.
The largest positive contributions were as expected. Food prices rose 1.7%, with a larger-than-usual seasonal increase in vegetable prices because of supply constraints after the Queensland floods earlier this year.
The annual reset of local body rates saw a 4.1% increase.
Other housing-related costs were also higher, with a 0.5% rise in rents and a 0.8% rise in the cost of new houses.
A stronger New Zealand dollar during the quarter accounted for some of the price falls, he said.
Audiovisual and computing equipment prices fell 4.8% and telco equipment fell 9.2%. Both groups were experiencing a major decline in prices because of advancing technology, but the strong dollar hurried them along.
Petrol prices fell 3.3% on a combination of the stronger dollar and lower crude oil prices, Mr Stephens said.
The largest downward surprises were in the non-tradeable sector, with electricity prices showing a rare quarterly decline of 3.3%.
There had been a campaign encouraging people to switch power companies which resulted in some suppliers offering better deals such as larger prompt-payment discounts.
International airfares fell 3.7% because of increased competition on the routes to Asia, and telecommunication services fell 3.5%, reflecting increased data caps for broadband and cellphone internet packets - effectively a quality-adjusted price fall, he said.
"Today's result was significantly below the Reserve Bank's forecast of a 0.7% increase. More importantly, the surprise was almost entirely on the 'stickier' non-tradeable side, and in at least one industry - electricity - where limited competition and persistent price increases have long been a bugbear.
"It's not obvious that this result can be repeated in coming quarters. The pace of switching of electricity providers is apparently slowing and further downward pressure on airfares depends on more new entrants to the market."
In other cases, such as internet services, the downward pressure on prices was likely to continue, Mr Stephens said.
In the September monetary policy statement, the Reserve Bank projected annual inflation to fall below 2% by the second half of next year.
Yesterday's results would greatly strengthen the Reserve Bank's confidence in that forecast. With the global situation a clear negative for the interest rate outlook since September, it was possible the central bank would explicitly signal a slower track for increases in the official cash rate in tomorrow's review, he said.
Westpac had shifted its forecast for the first OCR hike out to June next year, later than the median pick of March. That prediction reflected concerns about the flow-on effects of the rise in overseas funding costs in recent months. Yesterday's results supported the likelihood of an OCR hike at the later end of market expectations, Mr Stephens said.
