Paul Conway. Photo: Supplied
The Reserve Bank's (RBNZ) top economist says inflation risks are finely balanced, with the potential for inflation to be stickier than forecasts.
In a speech delivered on Wednesday, the central bank's chief economist Paul Conway outlined how the tight labour market and material shortages were key to New Zealand's high inflation.
He said spare capacity had started to emerge in the economy and would help slow down domestic price pressures, with inflation expectations likely to fall.
The latest Stats NZ figures put annual headline inflation at 4 percent from the year ended March.
Conway said good progress had been made in bringing inflation back to the RBNZ's 1 to 3 percent target, but the road to its 2 percent mid-point could happen faster or slower.
"There are some reasons to think that inflation may be more persistent than in our current projections in the near term. In other words, more 'sticky'. Most notably, domestic, or non-tradables inflation, and services sector inflation have held up more than initially projected," Conway said.
"However, there are also some reasons to think that inflation could fall more quickly than expected over the medium term. For example, increasing spare capacity in product and labour markets could translate into lower inflation more quickly than currently expected."
Conway added easing business and household inflation expectations could speed up the decline in price pressures.
"Reserve Bank research finds that above-target inflation over recent years prompted people to pay more attention to recent inflation and to update their inflation expectations more frequently," he said.
"As high inflation expectations become widespread, workers are more likely to bargain hard for wage increases."
Echoing comments from the RBNZ's recent monetary policy statement, Conway said a period of high interest rates was "necessary" to give the central bank confidence that inflation would return to its target band "over a reasonable timeframe".
