On top of higher petrol costs, people with mortgages may soon be slugged with an interest rate rise, and this unwelcome news could well be confirmed this week.
Markets are putting the odds of a hike on Tuesday at about 65 per cent, and all four major banks are expecting a rate rise.
If they’re right, it would be the second hike in a row after the Reserve Bank last month raised interest rates by 0.25 of a percentage point to 3.85 per cent. Many also think the RBA, led by governor Michele Bullock, will make it a hat-trick and hike again in May.
Even though markets seem fairly confident we’ll get a rate rise on Tuesday, there are plenty of sound economic reasons for the RBA to sit tight and not rush into a hike this week.
That is because the war in Iran is a problem for the “supply” side of the economy – the part that deals with production of goods and services – as opposed to the “demand” side (spending on goods and services, mainly by households).
While Australia does indeed have an inflation problem, it is far from obvious that rushing out a series of quick-fire rate rises is the best way to respond to this latest supply-side shock.
The main reason markets are betting on further rate hikes in the near future is pretty simple: inflation is too high. But we’ve known that for a while. So what changed in the last week or so to convince the big four to change their forecasts and predict a rate rise sooner than previously thought?
The obvious change has been the surging oil price, which is about 30 per cent higher than it was before the US and Israel’s war on Iran. This oil shock has arrived at a particularly unhelpful time for Australia’s inflation rate, which was already above the RBA’s 2 to 3 per cent target band, and is likely to shoot higher.
Economists also latched onto RBA commentary that was seen as suggesting it’s more open to raising rates. The RBA’s deputy governor, Andrew Hauser, last week said there would be “very genuine debate” about whether to raise rates this week, saying: “Inflation is too high. Higher prices don’t help that debate. But there are arguments on both sides and I think if ever there was a time when board members will earn their meagre salary, it will be this month.”
It is of course true that inflation is well outside the RBA’s 2 to 3 per cent target band, and the oil shock will worsen this. It’s also true that the RBA’s only real weapon for dealing with inflation is to raise interest rates. There will probably be a case for the RBA to raise rates again at some point soon, potentially in May, its next meeting after this week’s.
But just because inflation will be higher as a result of the Iran war, that doesn’t mean rushing to whack households with a rate rise this week is the right response, especially when this war is only two weeks old and no one knows what long-term impact it may have.
First, it’s worth remembering that oil shocks can also destabilise an economy as well as drive up inflation.
Indeed, the hit to households from higher petrol costs can act in much the same way as an interest rate hike – it detracts from households’ ability to spend on other things. AMP has estimated the oil surge could mean households need to spend an extra $14 a week or $730 a year on fuel. Most of us can’t avoid that added cost, so we make up for it by reducing spending elsewhere.
A second reason for the RBA not to rush a rate hike is the high amount of global uncertainty created by the war. This could be the worst oil crisis in 50 years, some analysts say, and it will take time to understand its many consequences, including for the huge number of businesses that use large amounts of fuel. Does it really make sense to throw a rate rise into the mix, or could this wait until the economy is (hopefully) a bit more settled in May?
Third, the high amount of uncertainty also means there’s some chance that the conflict dies down and the effect on inflation becomes relatively temporary.
In the past, the RBA has often been happy to “look through” temporary increases in inflation caused by one-off problems on the supply side of the economy. When prices get pushed higher because severe flooding has damaged the supply of certain fresh food, there’s no talk of raising interest rates in response.
After all, raising rates does not address the root cause of supply-side problems: it obviously won’t make petrol any cheaper. Instead, it just squeezes people with mortgages that little harder, forcing them to cut spending a bit more, in the hope this will eventually result in businesses lowering prices by a bit less than otherwise. It’s a roundabout, somewhat arbitrary and tough way of dealing with the problem of inflation.
Granted, the RBA doesn’t have any other tools at its disposal, and this time there are reasons why the RBA is more reluctant than usual to assume the inflation is temporary.
Most importantly, it’s convinced the economy has limited “spare capacity”, and it’s clearly concerned that inflation is too high.
It had these concerns well before Donald Trump unleashed energy market chaos by attacking Iran, but the recent oil price surge could make the RBA just that bit more uncomfortable with the risk of inflation becoming “entrenched”.
Why would inflation become entrenched?
The theory is that if you let inflation run above its target too long, people start to expect faster price rises and they then act accordingly: workers demand bigger pay rises, which employers then pass on through higher prices. This is why central bankers believe it’s important to contain the public’s “inflation expectations”. It is, however, more of a theoretical risk at present: it’s not clear that inflation expectations are taking off.
Finally, it’s worth remembering the central bank is also caught in the middle of a wider philosophical debate about how it should balance its goal of fighting inflation and its other mandate of full employment. Some want it to focus more narrowly on inflation.
For all these reasons, the RBA is no doubt keen to prove its inflation-fighting credentials, which may mean borrowers will this week face the second rate hike in as many months this year.
But considering all the uncertainty in the economy, the case for rapid-fire rate hikes is hardly watertight.
The Market Recap newsletter is a wrap of the day’s trading. Get it each weekday afternoon.
Clancy Yeates is deputy business editor. He has covered banking and financial services, and was previously national business correspondent in the Canberra bureau.Connect via X or email.
