(Adds analyst reaction, updates prices)
* RBNZ surprises by saying rate cut more likely
* Kiwi drops 1.5 pct, Aussie slips in sympathy
* Yields fall to record low as markets wager on easing
* Futures now fully priced for RBA rate cut by Aug
By Wayne Cole
SYDNEY, March 27 (Reuters) - The New Zealand dollar took a tumble on Wednesday after the country's central bank blindsided markets by saying the next move in interest rates would likely be down, abandoning its long-standing neutral stance.
The kiwi dollar NZD=D3 dived 1.5 percent to a two-week low at $0.6800, while bond and bill futures rallied sharply to leave yields at fresh all-time lows. Support is now around $0.6745.
The Australian dollar AUD=D3 was dragged down in its wake, falling 0.4 percent to $0.7102, though the Aussie did make hefty gains on its kiwi counterpart.
While the Reserve Bank of New Zealand (RBNZ) kept the official cash rate (OCR) at 1.75 percent, as expected, it surprised many by flatly stating "the more likely direction of our next OCR move is down." central bank cited a gloomier global outlook, particularly in major trading partners Australia, Europe, and China.
"This weaker outlook has prompted central banks to ease their expected monetary policy stances, placing upward pressure on the New Zealand dollar," the RBNZ said.
Slower growth in consumption at home and persistently low inflation added to the downside risks.
Yields on two-year government debt NZ2YT=RR dived 10 basis points to a record trough of 1.45 percent, the largest daily drop since mid-2017.
Bill futures 0#NBB: shot higher as investors priced in at least one quarter-point cut in rates, possibly as soon as the next policy meeting in May.
"The RBNZ has clearly changed tact today, focussing on the negative, and downgrading the positive," said Jeremy Couchman, a senior economist at Kiwibank.
"We now expect a 25 basis-point cut in May, followed by another cut in August – largely depending on the performance of the currency."
RBA NEXT?
The dovish shift follows similar moves by central banks abroad and will only add to speculation the Reserve Bank of Australia (RBA) will have to ease policy at some point.
The RBA holds its April policy meeting next week and might now choose to at least sound dovish in order to stop the Aussie dollar from rising.
"The continued dovish shift by G7 central banks, ongoing support by the Chinese authorities, and today's move by the RBNZ will keep pressure on the RBA to also move in the same direction, however reluctantly," said Su-Lin Ong, head of Australian and New Zealand strategy at RBC Capital Markets.
"It is, essentially, a global policy cycle."
Investors reacted by aggressively narrowing the odds on an easing 0#YIB: , with a quarter-point cut in the 1.5 percent cash rate now fully priced by August, instead of September.
Three-year bond futures YTTc1 climbed 5.5 ticks to 98.655, just below the all-time peak.
Yields on 10-year paper AU10YT=RR dropped another 5 basis points in the wake of the RBNZ news to strike a record low of 1.753 percent.
Bonds have rallied hard in the past week as the U.S. yield curve inverted, a potential signal of future recession there.
Inflation expectations have also swung sharply lower in the process, with a closely-watched market measure in Australia AUIL5YF5Y=R sinking to 1.97 percent from 2.15 percent just a few weeks ago.
That was easily the lowest reading since the measure began life back in 2016 and suggests the RBA might not reach the mid-point of its 2-3 percent target range at all in the next decade.