(Updates with fresh numbers)
By Wayne Cole and Rebecca Howard
SYDNEY/WELLINGTON, July 21 (Reuters) - The New Zealand dollar skidded to its lowest level in more than six weeks on Thursday after the country's central bank flagged more rate cuts ahead, saying the currency had to go lower to generate a much-needed rise in inflation.
The kiwi dollar NZD=D4 shed 1 percent in short order to hit $0.6954 after the Reserve Bank of New Zealand issued a dovish outlook on the economy. But it later recouped some of those losses to stand at $0.6984 by 0510 GMT, down 0.6 percent on the day.
It has now lost more than four percent over two weeks on talk of rate cuts.
The RBNZ bluntly stated that the currency was too high and a fall was "needed" to revive inflation, which slowed to just 0.4 percent in the second quarter.
"At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range," said the central bank.
Markets reacted by further narrowing the odds of a cut in the 2.25 percent cash rate next month 0#NBB: , while pricing in yet lower rates ahead.
"The RBNZ has a lot more room to cut in August and still leave an easing bias on the table to cut again in November if the exchange rate doesn't settle down to a more desirable level," said Annette Beacher, chief Asia-Pacific macro strategist at TD Securities.
Yields on two-year government paper were down at 1.885 percent NZ2YT=RR with investors front running the bank.
While yields on 10-year bonds were not far behind at 2.27 percent NZ10YT=RR , they are still very high by international standards and a major reason why the kiwi keeps defying RBNZ pressure for a substantial decline.
The Australian dollar made the most of the kiwi's lapse and climbed 0.8 percent to NZ$1.0720 AUDNZD=R , taking it a long way from the recent trough of NZ$1.0303.
The Aussie had less luck against the U.S. dollar, in large part because market also suspects that Australian interest rates will soon be cut. The Aussie was up 0.23 percent at $0.7491 AUD=D4 after having fallen two cents in five sessions.
Speculation is high that Reserve Bank of Australia (RBA) will cut its 1.75 percent cash rate in August, with the futures market pricing in around a 60 percent probability.
Much will depend on inflation figures for the second quarter due on July 27 where another soft result would greatly strengthen the case for an immediate easing.
Among Australian government bond futures, the three-year bond contract YTTc1 rose 2 ticks to 98.580, while the 10-year contract YTCc1 fell half a tick to 98.060.