The Reserve Bank of Australia is grappling with a deepening inflation threat driven by surging oil prices, with senior figures inside the bank increasingly worried the fallout from the Middle East conflict could force interest rates even higher, at a cost to Australian jobs and economic growth.
With two critical board meetings scheduled before Christmas, the RBA is caught between its obligation to bring inflation back within its 2 to 3 per cent target band and the very real damage that further monetary tightening could inflict on households and the broader economy.
Oil Prices at the Centre of the Inflation Problem
Crude oil finished last week at $US106 a barrel, and senior bank sources, speaking without authorisation to comment publicly, say prices are showing no sign of easing as the conflict in the Middle East extends to Saudi Arabia and the Gulf of Aden. The RBA's own economic forecasts, due to be updated next month, were built on oil prices running as much as $US20 a barrel lower than current levels.
Diesel prices are a particular concern, sitting near the levels reached when the Russia-Ukraine war began. Because diesel flows through transport, manufacturing and food production, its price has knock-on effects across virtually every part of the economy. Australian inflation rose by 0.4 per cent in August, and analysts note it would actually have fallen that month were it not for the jump in petrol prices.
The commodity shock is not limited to oil. LNG prices have more than doubled compared to pre-war levels, now sitting around $US28 per unit. Food commodity prices are being pushed up by a combination of higher energy costs, elevated fertiliser prices, and the impact of this year's severe El Nino weather event. Wheat prices have climbed 37 per cent this year, soybeans are up 24 per cent, sugar has soared 42 per cent, and cocoa beans have more than doubled in price. For a closer look at how these pressures have developed over recent years, see our analysis of the current state of Australia's inflation rate.
Jobs Data Complicates the Rate Decision
The RBA's dilemma became sharper after weaker-than-expected employment figures showed Australia's unemployment rate climbing to a five-year high of 4.7 per cent in September. Financial markets responded by significantly scaling back expectations of another rate rise at the November meeting. Before the jobs data, markets were pricing roughly a one-in-three chance the cash rate would be lifted to 4.85 per cent. That probability has since dropped to closer to one in five.
The bank has already attracted criticism for taking the official cash rate to a 15-year high of 4.6 per cent, with many borrowers reporting severe financial pressure. However, it is understood that most mortgage holders remain ahead on repayments, with significant balances held in offset accounts providing a buffer. Government spending at both state and federal levels is also cited as an ongoing contributor to inflationary conditions.
The RBA's Own Words on the Trade-Off
Governor Michele Bullock and senior RBA researcher Anthony Brassil addressed the dilemma directly in papers released last Friday, drawn from a conference on monetary policy trade-offs held earlier this month. They described the challenge posed by a supply shock, such as the current oil surge, when the bank must balance its twin goals 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," the pair wrote.
They added that in such circumstances, monetary policy cannot eliminate the underlying economic loss caused by the shock. It can only shape how that loss is spread across time.
Beyond the oil price shock, the RBA and its international counterparts are also monitoring inflationary pressures stemming from the global construction boom associated with artificial intelligence infrastructure investment. The combination of factors means the path back to the bank's inflation target remains uncertain, and the prospect of further rate rises has not been ruled out. Read more on how the RBA has been weighing its cash rate options in recent months.
