Reserve Bank of New Zealand governor Don Brash said he had probably surprised financial markets by endorsing a drop now equivalent to 350 basis points on interest rates, and signalling the prospect of another easing of 225 basis points by mid-1999.

The RBNZ does not set any official interest rates, but provides guidance for markets on where it believes the mixture of both interest rates and the currency should go.

The bank said its sharply revised monetary policy stance was due to more weakness than it had previously expected in the national economy, as well as a weak world economic outlook.

``As a result, inflationary pressures are expected to be lower than we thought earlier, allowing for easier monetary conditions,'' Brash said in his statement.

``From here on, the project further easing into mid-1999, but at a much more modest pace than we've seen recently,'' he added.

Since the first quarter of this year, as economic indicators have painted a picture of a slow growth and ever softer domestic demand, New Zealand's markets have pushed down indicator interest rates to about 6.75 per cent from over 9.00 per cent.

The Reserve Bank changed its expectation of domestic GDP growth going forward to about 1.6 per cent for the year to March 1999, down from an expected 3.0 per cent in its May forecast.

However, as 1999 develops, it still expects ``quite a strong pick-up, with growth averaging a little over four per cent in each of the years to March 2000 and 2001''.

In the near future, however, until that rapid rebound arrives, the RBNZ sees New Zealand's output gap, reflecting spare capacity in the economy, to be both larger and more long-lasting than previously projected.

``As a result of this excess capacity, and weak international process for both our imports and our exports, inflationary pressures seem likely to remain weak for some time,'' it added.

The bank is mandated by the government to keep inflation within a nought to three per cent range, and says its aim is to hold it as near as possible to the centre of that range.

The prospect of an economic slowdown came to almost a dead halt, followed by a sharp acceleration over the next two years raised the spectre of a bust-boom cycle, and Brash said the management of monetary policy would become extremely sensitive from here.

``We have no desire to over-do the easing; that would only require a more vigorous tightening further out, to the detriment of everybody,'' he said.

Markets retained a more short-term focus on Thursday after the statement, however, and in an atmosphere of near jubilations short interest rates rallied strongly.

The indicator 90-day bank bill rate fell to about 6.25 per cent from 6.70 per cent before the statement, while the share market, which has lost about 15 per cent so far this year, put in a hefty rise of over three per cent in its first hour.

The New Zealand Stock Exchange's Top-40 share index rallied 64 points to 2,033 by 10.45 am.

At the same time as share prices clambered out of their doldrums, banks started to cut mortgage rates, which are priced off wholesale market rates.

National Bank of New Zealand started the ball rolling by cutting its floating home loan rate by 75 basis points to 8.75 per cent from 9.50 per cent, effective September 8.

For the kiwi dollar, which has shared a general downtrend against the US dollar during 1998 with the Japanese yen and Australian dollar, the policy easing provoked a moderate sell-off that took the kiwi under 50 US cents in the morning.