The Reserve Bank (RBNZ) has slashed its benchmark interest rate by a greater than expected half a percent in the face of significant headwinds at home and abroad, sending the New Zealand dollar plunging.

Photo: RNZ / Dom Thomas

The official cash rate (OCR) was reduced to a record low 1 percent, when forecasters had been expecting a lesser quarter percent cut..

RBNZ Governor Adrian Orr said the risks have risen and the economy needed more stimulus to help counter the weaker outlook.

"In the absence of additional monetary stimulus, employment and inflation would likely ease relative to our targets."

The RBNZ held the rate steady in June after cutting by a quarter of a percentage point in May - its first move in more than two years.

The last time the RBNZ cut by such an amount was in March 2011 after the Canterbury earthquakes.

But Mr Orr said recent solid growth and employment numbers were positive, but the worsening international outlook was hurting New Zealand.

"Global economic activity continues to weaken, easing demand for New Zealand's goods and services. Heightened uncertainty and declining international trade have contributed to lower trading-partner growth."

Economy should improve

Mr Orr said low interest rates and increased government spending were expected to lift the economy over the coming year. Inflation was expected to reach its 2 percent target and employment should remain strong, which are the RBNZ's overriding policy objectives.

Interest rate decisions are now made by a committee of four RBNZ staff and three outside members.

A summary of the committee's deliberations showed discussion about the effect of increased government spending, soft wage growth, and a slowing housing market dampening consumer spending.

"They agreed that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives," the statement said.

Neither the statement nor the RBNZ's forward projections pointed to another rate cut, and suggested the OCR might be held at current levels through to 2022.

The New Zealand dollar slumped a full cent against the US after the decision, as investors were caught by surprise by the size of the cut. The Kiwi settled at around 64.4 US cents.

ASB Bank was quick to respond to the hefty cut, by reducing its floating mortgage rate by half-a-percent, but it trimmed its short term fixed rate by only a small amount.

An economist said the RBNZ had clearly decided to 'front-load' the support for the economy, and its commentary still had an easing bias.

"We forecast a further 25 basis point (quarter-percent) cut in November, but timing will be heavily influenced by global risks, which are fluid at present," ASB chief economist Nick Tuffley said.