The Reserve Bank of Australia (RBA) is facing what it considers a “worst nightmare”: persistent inflation driven by surging oil prices, with the cash rate already at a 15-year high of 4.6 per cent.
Senior sources within the bank, according to an article by Shane Wright, have expressed growing concern that oil prices—which last week closed at $US106 a barrel—are not falling as the war in the Middle East expands to Saudi Arabia and the Gulf of Aden. The RBA’s own economic forecasts were based on oil prices being as much as $20 lower.
Australian inflation rose 0.4 per cent in August, and would have fallen but for the increase in petrol prices. Diesel prices are particularly troubling for central banks, as they affect transport, manufacturing and food costs. LNG prices have more than doubled since before the war, while food commodities have soared: wheat up 37 per cent, soybeans 24 per cent, sugar 42 per cent and cocoa more than doubled.
The bank is also grappling with a weaker labour market. Unemployment rose to a five-year high of 4.7 per cent in September, lowering the market expectation of a rate rise at the November meeting from one in three to one in five. But the RBA is still concerned that inflation pressures, exacerbated by the war and the global AI data-centre build-out, will not abate.
In a paper released from a conference on monetary policy trade-offs, RBA Governor Michele Bullock and senior researcher Anthony Brassil highlighted the difficulty of a supply shock when the bank has a dual mandate of low inflation and full employment. “If prices are rising faster than nominal incomes, households experience a direct loss of purchasing power. At the same time, weaker activity may mean that unemployment and underemployment are already increasing,” they wrote. “The costs on both sides of the mandate are then visible together, and monetary policy cannot eliminate the real economic loss caused by the shock. It can only influence how that loss is distributed over time.”
Higher rates have put borrowers under pressure, although most have maintained large offset balances. A record $21 billion in interest was paid on home loans in the June quarter. Still, high inflation hits low-income earners hardest, especially those without mortgages who have faced steep rent increases over the past three years.
Globally, central banks have lifted rates over the past three months as inflation climbs. AMP chief economist Shane Oliver said the war against Iran and the Russian-Ukraine conflict were hurting the global economy through oil prices. “Disruptions in the Strait of Hormuz, coupled with recent Ukrainian strikes on Russian refineries, have driven up the cost of refining crude into end products,” he said.
The International Monetary Fund’s chief economist, Silvana Tenreyro, noted that the global economy had shown resilience through re-routing supplies and a shift to renewables, but she warned that the capacity to mitigate the drop in Middle Eastern oil production is nearly exhausted. A squeeze on global supplies through 2027 is increasingly expected.
The RBA will hold two critical meetings before Christmas, where it will have to decide whether to raise rates again or hold steady, weighing the risks of inflation versus unemployment.