* RBNZ doubles asset purchase programme to NZ$60 bln
* Adds inflation-indexed government bonds to purchases
* Actively considering negative interest rates
* NZ dollar falls over 1%, markets now pricing negative rate in 2021
(Adds economist quotes, updates NZ$)
By Praveen Menon and Swati Pandey
WELLINGTON/SYDNEY, May 13 (Reuters) - New Zealand's central bank on Wednesday doubled the amount of bonds it will buy as part of its quantitative easing programme and flagged a possible shift to negative interest rates as the COVID-19 pandemic wreaks havoc on the economy.
The Reserve Bank of New Zealand (RBNZ) left its official cash rate (OCR) at 0.25%, as expected, but said it was prepared to use additional tools "if and when needed" including further cuts and expanding its quantitative easing programme to include foreign assets.
The signal that rates could go below zero comes as the bank predicted a massive 21.8% contraction in June quarter gross domestic product, followed by a 23.8% expansion in the next quarter.
The New Zealand dollar NZD=D4 fell over 1% to $0.6010 after the RBNZ announcement. Financial market pricing for early 2021 shifted to a 100% chance of a cut, and beyond that a negative rate of -0.06% is now implied for the first time in the country's history. NZDOIS=
The central bank re-affirmed its forward guidance for the cash rate to remain at 0.25% until early 2021 but said negative rates "will become an option in future."
"The real challenge for us is to make sure that all options are available," RBNZ Governor Adrian Orr told reporters.
"We will be assessing the use of negative interest rates along with the other tools...One hopes we don't have to use all options."
The prospect of an unprecedented shift to negative interest rates comes as investors increasingly consider the possibility other central banks, including the U.S. Federal Reserve, may need to do the same amid falling consumer prices. the lines we suspect that the RBNZ is uncomfortable with the outlook. The statement repeatedly noted that the risks are to the downside," said Westpac economist Dominick Stephens.
"Forward guidance is regularly updated in response to changing circumstances, so we feel comfortable maintaining our forecast that the OCR will drop to -0.5% in November."
For now, the RBNZ said expanding its so called "large scale asset purchase" (LSAP) programme to NZ$60 billion ($36.2 billion) from NZ$33 billion was the "most effective way" to deliver stimulus, adding it would also start buying inflation-indexed government bonds.
Purchases of foreign bonds were also on the table which could happen "either because the RBNZ runs out of NZ bonds to buy and/or because they want the NZ dollar lower," economist at ANZ wrote in a note.
New Zealand is among a few countries to have successfully curbed the spread of the coronavirus with most businesses and offices set to reopen on Thursday after weeks of disruptions.
The government is expected to announce more fiscal stimulus in Thursday's annual budget, which ANZ says might include "a whopping debt issuance profile", providing the RBNZ with plenty of bonds to buy. ($1 = 1.6472 New Zealand dollars)