The Reserve Bank cut official interest rates for the first time in five years today in the face of a depressed economy and despite inflation at over 4%.
The move to lower the Official Cash Rate (OCR) to 8% from 8.25% was a slight surprise to markets who thought bank Governor Alan Bollard might wait until September as he indicated last month.
He indicated more cuts ahead and economists expect three more by Christmas.
The New Zealand dollar fell nearly US1c to US74.35 shortly after the announcement.
More "unpleasant" news had emerged since the Reserve Bank's Monetary Policy Statement in June and there was a risk the domestic economy would slow further, Dr Bollard said.
"Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated. Today's cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households."
With the economy widely thought to be in recession, even as the rate of inflation rises, economists had expected today's decision to be a close call, but most had thought rates would be left unchanged at this review with the first cut more likely in September.
BNZ economist Stephen Toplis said the move was a surprise.
"Not by the cut, because that was always 50-50, but by the fact they've effectively given the green light to interest rate markets to rally strongly. "It was more the dovishness of the overall statement.
"We thought they might try to hold the market in check to make sure it didn't get carried away. In fact they've said go for it, with the clear expectation that they're going to be lowering the official cash rate further, and their analysis that all is done and dusted.
ANZ chief economist Cameron Bagrie said "it was a very prudent response to what's obviously a very challenging economic environment out there." "The Reserve Bank's economic assessment looks to be very similar to our own in that conditions are just not stabilising, and in that environment they needed to act.
ANZ expects three more cuts before the end of the year and that would affect the NZ dollar.
Goldman Sachs JB Were economist Shamubeel Eaqub said his firm had been calling for a cut for some time.
"The economy is sinking into recession, and monetary policy needs to be far less restrictive.
"We think further easing is required to prevent further unintentional tightening for the household sector, and we think the economy will probably recover at some stage in the second half of 2009.
"They need to do a series of easings until monetary policy is neutral at around 6%." Monetary policy had been reasonably tight for some time and was now restraining activity and medium term inflation pressures, Dr Bollard said.
"Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further." Recent oil and food price increases meant annual consumer price inflation should peak around 5% in the September quarter of this year, Dr Bollard said.
But the Reserve Bank expected inflation to return inside the 1-3% target band in the medium term.
"The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed," he said.
Economic activity was likely to remain weak for the rest of 2008.
"The ongoing correction in the housing market, together with the very high oil prices, will limit household spending and constrain the extent of recovery," Dr Bollard said.
"However, high export prices and an expansionary fiscal policy are expected to contribute to a gradual pickup in activity through 2009." The central bank, which lifted interest rates by a total of 1%age point last year to cool strong domestic demand, said last month that it was likely to start easing policy later this year.
New Zealand's economy shrunk a seasonally adjusted 0.3% in the three months to March, and most analysts think second-quarter activity was as bad or worse, with the weakness possibly spilling over into the third quarter.
