WELLINGTON - NEW Zealand's economy contracted by its biggest amount in eight years as the recession deepened in the third quarter, backing the case for more central bank rate cuts to cushion the impact of the global slowdown.

Gross domestic product fell a seasonally adjusted 0.4 per cent in the three months to Sept 30, as consumers spent less, businesses cut investment and weak global markets and prices hit exports, data showed on Tuesday.

The drop was the biggest quarterly decline in GDP since the June quarter 2000, and followed a 0.2 per cent fall in the previous quarter, backing market views that the Reserve Bank of New Zealand (RBNZ) will keep cutting rates.

'This means interest rates still have to come down,' said JP Morgan chief economist Stephen Walters. 'We suspect the recession will last for another one or two more quarters to come.'

The New Zealand dollar was unmoved by the data, last trading steady around $0.5720/30. The yield on the March bank bill contract was unchanged at 4.41 per cent compared with the official cash rate of 5 per cent.

A Reuters poll had expected GDP to contract 0.5 per cent.

The RBNZ had forecast a 0.3 per cent drop.

New Zealand is in its first recession since 1997-98, which followed the Asian financial crisis. However, economists and the central bank are divided on whether the current downturn will continue.

Private forecasters expect a continuation into the middle of 2009, but the central bank governor said earlier this month the economy will probably emerge from a 'shallow' recession in the fourth quarter into a period of 'shallow' growth.

The third quarter's decline was led by a fall in household consumption, manufacturing, export volumes, and business and housing investment, which were partly offset by higher agriculture production and government spending.

The central bank has cut rates four times since July by a total of 325 basis points to a five year low of 5 per cent, and said further small cuts are likely.

Most analysts see rates falling to 3.5 per cent by the middle of 2009. The next rate review is on Jan 29.

Average annual growth slowed to 1.7 per cent in the year to the third quarter, in line with expectations, from 2.5 per cent in the previous quarter.

The economy in the third quarter was 0.1 per cent smaller than the same quarter a year earlier, compared with 1 per cent growth in the previous quarter. It was the first contraction on an annual basis since the third quarter 1998. -- REUTERS