By Lucy Craymer

WELLINGTON (Reuters) -New Zealand's central bank slashed its benchmark cash rate for the first time since March 2020, sending the local dollar tumbling as policymakers flagged more cuts over the coming months saying inflation was converging on its 1% to 3% target.

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.

The policy easing was in line with market pricing but defied most economists' expectations, with 19 of 31 economists in a Reuters poll having forecast the central bank to hold steady as they have 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.

“The pace of further easing will depend on the Committee’s confidence that pricing behaviour remain consistent with a low inflation environment, and that inflation expectations are anchored around the 2 percent target,” it added.

Investors reacted by knocking the kiwi dollar down 0.75% to $0.6032, 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 29 basis points of easing by October and 67 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 announced they would cut their mortgage lending rates.

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.

The 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 has 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.

The rate hikes have sharply slowed the economy with meagre first quarter growth and recent data indicating still-subdued momentum.

New Zealand joins other central banks that are starting to ease rates. The European Central Bank, 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. The Reserve Bank of Australia last week ruled out near-term rate cuts.