WELLINGTON, Sept 18 (Reuters) - New Zealand's economy shrank more than expected in the second quarter as construction remained in decline and global uncertainty weighed, increasing expectations of a steeper rate cut in October.

Official data out on Thursday showed gross domestic product (GDP) fell 0.9% in the second quarter from the prior quarter, worse than analysts' and the Reserve Bank of New Zealand's forecasts of a 0.3% fall.

New Zealand's economy has contracted in three of the last five quarters.

Annual GDP decreased 0.6%, Statistics New Zealand data showed. The market had expected it to remain unchanged.

Following the weaker-than-expected data, two-year swap rates slid 10 basis points to 2.7290%, their lowest since early 2022. The kiwi dollar fell 0.5% to $0.5932 , well off an overnight peak of $0.6007.

The market is now pricing in a further 58 basis points of cuts to the official cash rate (OCR), up from 48 basis points before the GDP data was released and a 20% chance that the central bank will cut by 50 basis points in October.

In August, the central bank flagged two more rate cuts this year as it noted spending by households and businesses has been constrained by uncertainty, falling employment, higher prices for some essentials and declining house prices.

"The weaker than expected GDP outcome will no doubt encourage the RBNZ in its intentions to cut the OCR further this year," Westpac senior economist Michael Gordon said in a note.

Westpac is now expecting the central bank to cut by 50 basis points in October and by a further 25 basis points in November.

Weakness in the economy was across the board with the construction sector remaining in decline, manufacturing hurt by slowing goods exports and the service sector remaining weak as tourism stagnates.

The economy has been further hurt by a decision by the United States in April to levy import tariffs on products from a range of countries including New Zealand. The tariff has since been set at 15%, above the 10% rate for goods from neighbouring Australia.

IMPROVEMENT EXPECTED IN THIRD QUARTER

New Zealand's Finance Minister Nicola Willis said international turmoil and uncertainty relating to tariffs clearly had an impact on firms' and households' willingness to make investment decisions.

But there are indications the economy has begun to turn the corner in the third quarter, with manufacturing and services indexes along with monthly employment and card spending data improving slightly.

ANZ Senior Economist Matthew Galt said in a note that signs that growth has returned in the third quarter, albeit in a muted manner, suggest the country will avoid another technical recession.

But Galt added that while the bar was higher at the end of a monetary policy cycle for outsized moves if data remained lacklustre over coming weeks, a 50 basis point cut was absolutely a possibility.

Reporting by Lucy Craymer; Editing by Jamie Freed

Our Standards: The Thomson Reuters Trust Principles., opens new tab

New Zealand economy contracts sharply, fuelling bets of steeper rate cuts