The Reserve Bank of New Zealand has lowered the Official Cash Rate to 6.5%. It was previously 7.5%.
Though the amount of the cut - a full percentage point - was unprecedented, the move was expected.
Governor Allan Bollard said on Thursday the cut is needed because international market turmoil means the outlook for New Zealand has worsened since the last review.
Dr Bollard said he expects inflation to fall to within the Bank's 1% - 3% band by the middle of next year, but warned that cost pressures remain despite falling oil and commodity prices.
He singled out electricity prices, local authority rates and construction costs as remaining stubbornly high despite the recession.
The cut was the third this year.
The Reserve Bank previously cut the OCR by half a percentage point to 7.5% on 8 September and from 8.25% to 8% on 24 July. That was the first cut since July 2003.
Statistics New Zealand announced on Tuesday the Consumer Price Index rose 1.5% in the September quarter, taking the annual rate of inflation to 5.1% - the highest for 18 years.
New Zealand is technically in a recession. Gross Domestic Product was down 0.2% for the June quarter and 0.3% for the March quarter.
The last recession, in 1997-98, lasted nine months.
Statement by Reserve Bank Governor
Dr Bollard commented that "ongoing financial market turmoil and a deteriorating outlook for global growth have played a large role" in shaping the decision to reduce the Official Cash Rate (OCR) from 7.5% to 6.5%.
"Economic activity in New Zealand will be further constrained, relative to the outlook presented in our September Monetary Policy Statement, by these international developments.
"New Zealand can expect to face lower demand for exports and credit is likely to be less readily available. In this environment consumers and businesses are likely to be more cautious and curtail spending.
"The reduction in domestic spending will be partly offset by the depreciation of the New Zealand dollar over the past few months, falling oil prices and the recent loosening of fiscal policy.
"With weaker short-term growth and sharply lower oil prices we now expect that annual CPI inflation will return to the target band of 1% -
3% around the middle of 2009.
"However, we still have concerns that domestically generated inflation (particularly in labour costs, local body rates, electricity prices and construction costs) is remaining stubbornly high.
"Consistent with the Policy Targets Agreement, the Bank's focus will remain on medium-term inflation. Should the outlook for inflation evolve as projected we would expect to lower the OCR further.
"However, the timing and extent of OCR reductions over the coming months will depend on evidence of actual reductions in domestic cost pressures as well as how the global financial developments play out."
Action by central banks
Central banks around the world slashed their interest rates in an unprecedented, co-ordinated move on 8 October.
The Bank of England cut its rates from 5% to 4.5% and the US Federal Reserve went from 2% to 1.5%. Similar reductions were made by Canada, Sweden and Switzerland.
The Reserve Bank of Australia cut its rate from 7% to 6% on 7 October.