UPDATE 2-NZ economy shrinks for 5th straight quarter in Q1

* Q1 GDP confirms longest NZ recession on record

* NZ economy contracts 1 pct qtr/qtr

* Q1 GDP 2.7 pct lower than a year ago

* Lower rates to stay for longer (Adds comment, market reaction, background)

WELLINGTON, June 26 - New Zealand's economy contracted for the fifth quarter in a row in the first three months of this year, reinforcing expectations the central bank will keep interest rates at current low levels well into 2010.

Weakness was most evident in the manufacturing, transport, wholesale trade and retail sectors and analysts said the decline was likely to continue in the second quarter.

"The outlook remains challenging. We expect a further decline in the second quarter," said ASB chief economist Nick Tuffley, adding an improvement in business confidence suggested activity was expected to stabilise over the second half of 2009.

Gross domestic product fell a seasonally adjusted 1.0 percent in the first quarter, matching a revised 1.0 percent drop in the previous three months, as consumers spent less and businesses cut investment, data showed on Friday.

Economists in a Reuters poll had forecast a 0.7 percent contraction, while the Reserve Bank of New Zealand (RBNZ) had predicted a 1 percent fall.

The central bank forecast earlier this month the contraction to slow to 0.3 percent in the June quarter.

The New Zealand dollar <NZD=> fell nearly half a cent after the data to a low of $0.6412, but has clawed back to $0.6439/44 levels on the back of a broad U.S. dollar weakness.

The interest rate market was little moved by the data, with the one-year interest rate swap <NZDSM3NB1Y=> bid around 3.0 percent, reflecting expectations the policy rates will rise from the current record low 2.5 percent.

RATES SEEN ON HOLD

The central bank has cut its cash rate by 575 basis points since July last year. It left the rate steady on June 11, saying it was seeing the first tentative recovery signs, but has pledged to keep the rate at or below its current level until late 2010.

"We don't think it (GDP data) will bring the RBNZ back into play but it just reinforces their lower-for-longer message on rates," said ANZ-National senior economist Khoon Goh.

But some analysts think weak consumer and business activity showed the economy needed further stimulation.

"The RBNZ will need to respond with further policy accommodation and the risk is that our forecast of 50 basis points cut could be eclipsed by a larger cut in the official cash rate in July," said Citi economist Josh Williamson.

A Reuters poll has 14 of 16 economists expecting the central bank to hold the rate steady at its review on July 30, with the median view that rates will be held at 2.5 percent well into 2010.

The first quarter GDP data marked the longest contraction on record for New Zealand as the relatively small, open economy struggles amid the global downturn. The last time the economy had a bigger contraction was in March 1991, when the economy shrank 2.6 percent.

RBNZ Governor Alan Bollard said this month the economy was near its low point and should start growing by the end of the year, but strength in the New Zealand dollar could derail a recovery. Since early March, the local dollar has risen almost 30 percent against the U.S. currency.

"The market pricing in rate hikes early next year is just madness," said RBC Capital Markets senior economist Su-Lin Ong, adding the more timely figures did show signs of stabilisation, but any recovery would be extremely subdued.

The 1 percent drop in New Zealand's GDP was smaller than the 1.4 percent fall in the United States, Britain's 1.9 percent and the euro zone's 2.5 percent. Only Australia, New Zealand's biggest trading partner, has dodged a recession so far among developed economies. (Additional reporting by Gyles Beckford and Adrian Bathgate) ($1=1.547 New Zealand Dollar)