(Recasts, adds comment from economists, market reaction) New...

(Recasts, adds comment from economists, market reaction)

New Zealand's central bank Thursday said further rate cuts are likely as it sets its sights on the high New Zealand dollar and perilously low inflation.

"At this stage it seems likely that further monetary policy easing will be required to ensure that future average inflation settles near the middle of the target range," it said in an economic update ahead of the August 11 rate decision.

The bank is mandated to keep inflation in a target range of 1 percent to 3 percent.

Annual inflation is currently running at 0.4 percent and has been below the central bank's target band since the fourth quarter of 2014.

New Zealand, like most of the Asian region is struggling with tepid inflation or even deflation as too many goods chase too little demand. But, unlike many central banks globally, New Zealand has been reluctant to cut rates given an overheated housing market.

Earlier this week, however, the central bank paved the way for rate cuts by announcing new curbs on mortgage lending that are geared toward dampening the housing market.

New Zealand house prices have increased by around 50 percent since 2010, driven by strong immigration, low mortgage rates and sluggish housing supply.

It noted Thursday that house price inflation "remains excessive" but said the new macro-prudential tools are aimed at mitigating any risk to financial stability.

On Thursday the central bank emphatically said the high New Zealand dollar was hindering efforts to meet its inflation target. "A decline in the exchange rate is needed."

Despite rising capacity pressures and some recent increases in fuel prices, the stronger exchange rate implies that the outlook for inflation has weakened since the June statement, it added.

As a result "monetary policy will continue to be accommodative," the central bank said.

The New Zealand dollar fell and was trading at US$0.6964 as the market moved to fully price in an August rate cut, versus an 82 percent chance of a cut before the announcement.

"The RBNZ made very strong comments on the level of the NZD," said ASB Bank Senior Economist Jane Turner.

"The RBNZ’s statement reinforces our view that the RBNZ will cut the OCR to 2.0 percent in August, then cut again to 1.75 percent in November. Before this statement, we had viewed that there was a very high threshold for the RBNZ to cut to 1.75 percent," she said.

Kiwibank Senior Economist Zoe Wallis said she still expects a 25 basis point rate cut in August but "we now expect them (RBNZ) to have to cut by another 50 basis points to a terminal rate of 1.50 percent."