The Reserve Bank has cut interest rates in response to low inflation pressures and expected weakening in demand.

Photo: RNZ / Diego Opatowski

The central bank reduced the Official Cash Rate from 3.5 to 3.25 percent and signalled further decreases may be needed.

Lending rates began to fall and the dollar dropped swiftly after the announcement.

ANZ is to lower the interest rate on its floating and flexible home loans by 0.25 percent, to 6.49 percent for floating and 6.60 percent for flexible loans.

Kiwibank and ASB Bank are also lowering mortgage rates by 0.25 percent and other banks are expected to follow.

The New Zealand dollar dropped about 1.5 cents to US70.4 cents.

Inflation low

Reserve Bank governor Graeme Wheeler said inflation was low due to the high New Zealand dollar and an expansion in firms productive capacity, while wage and price expectations had been subdued.

The economy was growing at about 3 percent annually, underpinned by low interest rates, high immigration and robust construction activity.

But Mr Wheeler said dairy prices were expected to remain weak, and along with higher fuel prices, would slow income and demand growth.

"If we delayed we ran the risk that further down the track we'd have to be more aggressive," he said.

The move would delay the expected rise in inflation back to the middle of the Reserve bank's 1 to 3 percent target band.

Mr Wheeler said the dollar has fallen from its recent peak in April but remained overvalued and a further significant decline was justified.

The governor said a cut in rates was appropriate given low inflationary pressures and the expected weakening in demand, and to ensure that medium term inflation moved towards the 2 percent mid point.

He expected further cuts may be needed, though he said that would depend on the data.

The Reserve Bank's forecasts indicate another cut to 3 percent later in the year, where it will remain until the middle of 2017.

Falling dairy prices and near-zero inflation had some economists, business groups and unions urging a rate cut. The counter-argument had been whether a cut would fuel already soaring house prices in Auckland.