FILE PHOTO: A security guard stands in the main entrance to the Reserve Bank of New Zealand located in central Wellington, New Zealand, July 3, 2017. REUTERS/David Gray/ File Photo

By Lucy Craymer

WELLINGTON (Reuters) -New Zealand's central bank cut its policy rate by 25 basis points to a three-year low of 3.00% on Wednesday, and flagged further reductions in coming months as policymakers warned of domestic and global headwinds to growth.

The central bank's dovish tone caught markets offguard and sent the New Zealand dollar tumbling 1.2% to a 4-month low at $0.5822, while two year swap rates slumped as deep as 2.96% -- their lowest level since early 2022.

The Reserve Bank of New Zealand said the economy had stalled in the second quarter, and lowered its projected floor for the cash rate to 2.55%, from 2.85% forecast in May. Two members of the six-strong policy committee even voted to cut by 50 basis points on Wednesday.

The quarter point cut in the official cash rate was in line with a large majority of economists in a Reuters poll, but the central bank's broadly bearish tone around economic risks jolted markets.

“Cautious behaviour by households and businesses could further dampen economic growth," the RBNZ said in its accompanying policy statement.

"If medium-term inflation pressures continue to ease as expected, there is scope to lower the OCR further," it added.

The central bank has slashed rates by 250 basis points since August 2024 to underpin a fragile recovery, but it said "consumption and investment demand appear to have weakened in the second quarter of 2025, partly in response to heightened trade policy uncertainty" after a shakeup in U.S. tariff policy in April this year.

"The fact that members gave serious consideration to an outsized 50bp cut is quite telling," said Abhijit Surya, a senior APAC economist at Capital economics.

The central bank forecast in its Monetary Policy Statement that the cash rate will be at 2.71% in the fourth quarter of 2025, below a forecast of 2.92% in May. In the first-quarter of 2026 it expects it to average 2.55%, lower than the previously forecast 2.85%.

"It is possible that pessimistic sentiment, together with the initial negative effects of the global tariff shock, have dampened the effects of the reduction in the OCR since last August," RBNZ said in its meeting minutes.

TWO MORE RATE CUTS?

Markets quickly moved to narrow the odds on two more cuts, implying a 50% chance of a move in October and over 100% for November.

The bottom is now implied around 2.57%, compared to 2.76% before the RBNZ announcement.

Bank of New Zealand head of research Stephen Toplis said that given the dovish tone of the central bank's statement, the BNZ is now forecasting 25-basis-point cuts in both October and November.

ANZ bank is also now expecting two quarter point cuts in October and November, from previous expectations for easings in November and February, saying the RBNZ was "much more dovish than expected." A global front-runner in withdrawing pandemic-era stimulus, the RBNZ lifted rates 525 basis points between October 2021 and September 2023 to curb inflation in the most aggressive tightening since the official cash rate was introduced in 1999.

The punishing borrowing costs, however, took a heavy toll on demand and tipped the economy into recession last year. While, the South Pacific nation has emerged from the slump, growth remains weak and is being further hampered by a slowdown in the global economy and the government’s tight fiscal policy. Adding to the domestic economic stress, unemployment is also rising. New Zealand's annual inflation remains within the RBNZ's 1%-3% target band at 2.7% and the central bank is forecasting it will increase to 3.0% in the third quarter.

(Reporting by Lucy CraymerEditing by Shri Navaratnam)