Wellington  - New Zealand's central bank cut its benchmark interest rate from 8.25 per cent to 8 per cent on Thursday, its first reduction for five years.

The Reserve Bank had kept its official cash rate (OCR) at 8.25 per cent - one of the highest in the developed world - for 12 months in a bid to contain inflation within its target range of 1 to 3 per cent.

With most analysts convinced that New Zealand is in a recession, bank governor Alan Bollard said "more unpleasant international news" had emerged since he last reviewed monetary policy in June and there was a risk the domestic economy would slow further.

"Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated. Today's cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households."

Bollard said that inflation was likely to peak in the September quarter because of recent oil and food price increases, but he expected it would return inside the target band in the medium term.

He said economic activity was likely to remain weak for the rest of the year and an ongoing correction in the housing market, together with very high oil prices, would limit household spending and constrain the extent of recovery.

"However, high export prices and an expansionary fiscal policy are expected to contribute to a gradual pickup in activity through 2009," he said.

Bollard predicted further cuts in the interest rate if the inflation outlook continued to improve. (dpa)