The Reserve Bank of Australia (RBA) faces a daunting challenge as the war against Iran continues to push up oil prices, exacerbating inflation risks. Senior bank sources, speaking anonymously, expressed concern that oil prices, which closed last week at $US106 a barrel, show no signs of easing as the conflict spreads to Saudi Arabia and the Gulf of Aden. This poses a significant threat to the RBA’s efforts to bring inflation down to its 2-3 per cent target, which has been exceeded for three of the past four years.
The RBA is grappling with the trade-off between controlling inflation and the potential economic damage from higher interest rates. Diesel prices, a critical factor for transport, manufacturing, and food production, have surged to levels last seen during the Russia-Ukraine war. Australian inflation, which rose by 0.4 per cent in August, would have declined but for the increase in petrol prices that month. Commodity prices across the board, including LNG, wheat, soybeans, sugar, and cocoa, have also climbed due to the war and adverse weather conditions.
Weaker-than-expected job figures last week, showing unemployment rising to a five-year high of 4.7 per cent in September, have led financial markets to reduce expectations of further interest rate hikes. Before the figures, markets believed there was a one-in-three chance the RBA would raise the cash rate to 4.85 per cent in November, but this has now dropped to one in five. However, the RBA remains focused on inflation pressures driven by the war and the global AI construction boom.
RBA governor Michele Bullock and senior researcher Anthony Brassil highlighted the difficulties posed by supply shocks, such as the current surge in oil prices. They noted that monetary policy cannot eliminate the real economic loss caused by such shocks but can influence how that loss is distributed over time. The bank has already faced criticism for raising interest rates to a 15-year high of 4.6 per cent, which has put borrowers under pressure. Despite this, most borrowers remain ahead on their repayments, with many holding large balances in offset mortgage accounts.