The Reserve Bank cut the Official Cash Rate on Thursday by a larger than expected half a percentage point to 7.5%. Home loan rates have begun to fall in response.
Reserve Bank Governor Alan Bollard says the global economic slowdown and high interest rates allowed him to cut the benchmark rate more than expected.
Economists had predicted a cut of a quarter percentage point.
Dr Bollard says after a period of high food and energy prices inflation had probably peaked at 5%. However, he told Checkpoint on Thursday that people should not necessarily expect further significant drop in rates.
"We have always said that these cuts are predicated on the New Zealand dollar not dropping too far too fast. We wouldn't want the international markets to think this signifies there's something wrong with the New Zealand economy - there isn't at all.
"We're just looking to get some of the rate cuts to where it will make a difference."
At the last review, on 24 July, Dr Bollard also surprised markets, cutting rates by a quarter of a percentage point to 8%.
Business New Zealand economist John Pask welcomed Thursday's cut as a "shot in the arm" for business, as long as it does not push the dollar too low, thereby increasing imported inflation.
Banks quick to act
The New Zealand dollar lost more than 1 cent in response to Thursday's announcement, and banks were quick to drop home loan rates.
Kiwibank was quickest off the mark, immediately cutting its variable mortgage rate by half a percentage point to 9.70%, and reducing its two-year fixed rate to 8.49%.
Westpac followed suit dropping its variable mortgage rate by half a percent.
ASB and BNZ banks did the same, although they did not pass on the Reserve Bank's full cut in their fixed mortgage rates.
ASB says it has only been able to fractionally cut its two-year fixed rate, as the cost of borrowing money overseas remains extremely high.
One of the smaller banks, Taranaki Savings Bank, says its has matched Kiwibank's move to make sure its two-year fixed rate remains the lowest in the market.
TSB chief executive Kevin Rimmington says he expects at least one more interest rate cut by the Reserve Bank before the end of this year.
ANZ and National banks say they have yet to decide on any cuts.
Mortgage Brokers Association spokesperson Bruce Patten says with both house prices and interest rates dropping, first-home buyers are at last beginning to re-enter the market.
The central bank's surprise decision to cut interest rates by 50 basis points shaved more than a 1c off the New Zealand dollar. At 5.20pm on Thursday, it was trading at US65.07c.
Dr Alan Bollard told Morning Report on Thursday he expects financial markets to settle down in a couple of days, and that general interest rate track is in fact very close to market expectations.
Reserve Bank statement
In his statement Reserve Bank governor Alan Bollard said the New Zealand economy is experiencing a "marked slowdown", led primarily by the household sector.
In addition, the outlook for the global economy has deteriorated further in the wake of continued financial market turmoil, and the New Zealand business sector is coming under pressure from both rising costs and falling demand.
"While domestic activity is likely to pick up late this year as a result of personal tax cuts, increased government spending and rising rural incomes, we expect a prolonged period of household sector adjustment and below-average growth," Dr Bollard's statement said.
"The weakness in economic activity is expected to translate into lower inflation pressures in the medium term.
"Headline inflation is expected to peak around 5% in the current September quarter before trending down thereafter. However, food price inflation, exchange rate depreciation and higher wage costs will tend to keep headline inflation at elevated levels through 2009.
"With medium-term inflation pressures expected to ease, it is appropriate to move towards a less restrictive monetary policy stance.
"Looking ahead, the scale and timing of further official cash rate reductions will depend on signs of declining inflation pressures and on exchange rate adjustments."