By Lucy Craymer

WELLINGTON (Reuters) -New Zealand’s central bank slashed its benchmark rate for the first time since March 2020 and flagged more cuts over coming months, saying inflation was nearing its 1% to 3% target in a sharp dovish tilt that sparked a sell-off in the dollar.

The decision to reduce rates by 25 basis points to 5.25% came almost a year ahead of the Reserve Bank of New Zealand’s (RBNZ) own projections, taking some market players by surprise and prompting bets of an aggressive easing path through to the end of 2025.

Markets had priced in almost a 70% chance of a quarter-point reduction following a string of softer economic data, but the cut defied most economists’ expectations, with 19 of 31 economists in a Reuters poll having forecast the RBNZ to hold steady as it has since May 2023.

“The Committee agreed to ease the level of monetary policy restraint by reducing the OCR (official cash rate),” the central bank said in its statement, and signalled more cuts ahead depending on how inflation evolves.

Investors reacted by knocking the kiwi dollar down 1% to $0.6015, erasing most of the 1% gains made overnight as soft U.S. producer price data slugged the U.S. dollar. Swaps shifted to imply another 32 basis points of easing by October and 71 basis points of easing by year end. Rates are seen near 3.0% by the end of 2025, well below the RBNZ’s projection. Bank bill futures also jumped.

ASB Bank chief economist Nick Tuffley said he expects the RBNZ will continue steadily cutting the cash rate by 25 basis points in consecutive meetings.

“If inflation pressures evaporate faster than expected, the RBNZ may need to hasten the return to a more neutral setting of around 3.25%,” Tuffley added. ASB Bank along with Kiwibank, Westpac and ANZ bank announced cuts to their mortgage lending rates.

The central bank did strike a note of caution, emphasising that policy will need to remain restrictive for a further period, but it still forecast the cash rate at 3.85% by end-2025.

“Although the Bank seemed to strike a cautious tone about further policy easing, we think it will cut rates more aggressively than many are anticipating,” said Abhijit Surya, economist at Capital Economics.

The market’s views on further rate reductions reflected the central bank’s own gloomy economic projections.

RBNZ Governor Adrian Orr told a post-policy press conference that growth has weakened since May and concerns around pricing expectations have dissipated.

“It’s a good news story of pricing behaviours changing rapidly,” Orr said.

The central bank expects New Zealand to tip back into a technical recession – two consecutive quarters of economic contractions – this year after suffering a similar slump in both 2023 and 2022.

NZ JOINS GLOBAL EASING

The RBNZ’s forward guidance suggested at least three more cuts by the middle of next year, projecting the cash rate at 4.9% in the fourth quarter of 2024 and 4.4% in the second quarter of 2025. Previously, it had not expected to start cutting rates until the middle of 2025.

New Zealand joins a global impulse to ease rates. The European Central Bank, the Bank of England, Canada, Sweden and Switzerland have all cut interest rates and an increasing number of analysts are now pencilling in a half-a-percentage-point rate cut for the Federal Reserve’s September meeting.

New Zealand’s neighbour Australia, however, is an exception to the global easing trend, with the Reserve Bank of Australia last week ruling out near-term rate cuts.

The RBNZ minutes of the meeting, released alongside its statement, said the Committee observed that the balance of risks has progressively shifted since the May Monetary Policy Statement.

“With a broad range of indicators suggesting the economy is contracting faster than anticipated, the downside risks to output and employment that were highlighted in July have become more apparent,” the minutes added.

A global front-runner in withdrawing pandemic-era stimulus, the RBNZ lifted rates 525 basis points since October 2021 to curb inflation in the most aggressive tightening since the official cash rate was introduced in 1999.

New Zealand’s annual inflation has come off in recent months and is currently running at 3.3% with expectations that it will return to the central bank’s target band in the third quarter of this year.

Kiwibank chief economist Jarrod Kerr said the focus now is on the magnitude of rate cuts needed.

“They’re cutting back to neutral,” Kerr said.

“We are going to see 250 basis to 300 basis points of rate cuts in this cycle and that’s what’s going to get the attention of businesses and that’s what’s going to get the attention of households.”