The Iran conflict will see reduced oil supply and higher inflation. Picture: Fadel Itani / AFP)
ANALYSIS
Not long after the US and Israel began their strikes on Iran over the weekend, huge queues began to form at Australian petrol stations, as we rushed to fill our cars before Middle Eastern conflict translated into higher oil prices.
Iran only produces about 3 per cent of the world’s oil, but around 20 per cent of the world’s crude is shipped through a narrow waterway in the Persian Gulf known as the Strait of Hormuz.
Restricted access to that route would mean a shortage of oil supply, which means rising prices. As a rule, a US$10 a price per barrel oil increase usually translates to about a 10 cent per litre price hike at the bowser.
As it turns out, merely the speculation was enough to have an effect, with oil prices having already soared by 8 per cent by Monday.
And Australian petrol prices have already skyrocketed.
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Despite, as economist Saul Eslake noted on ABC radio, there’s no way the petrol “the service stations are selling now has come from the Middle East at elevated prices”, the flow-on effect into Australian inflation has already begun.
And now, we wait to see how the RBA responds.
US President Donald Trump is overseeing ’Operation Epic Fury’ against Iran. Picture: Daniel Torok, The White House, AFP.
You may feel that a rise in petrol prices does not warrant a rate hike on its own, especially as US President Donald Trump hopes to have the conflict over and done with quickly. But a rise in oil prices will filter all the way through the Australian economy.
Wide-ranging CPI effects
The Australian Bureau of Statistics (ABS) produces a monthly Consumer Price Index (CPI), which is used by the RBA to gauge inflation levels and inform its rate decisions.
In this, higher fuel prices shows up under transport costs. Fuel makes up only a few percentage points of the CPI, but oil underpins much more than just petrol.
It also inflates freight and logistics, pushing up the cost of moving goods from warehouse to doorstep.
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Then there is tourism, especially in terms of airfares. Major airlines will be passing on their increased jet fuel costs to travellers in higher airfares.
Utilities will also be affected, in cases where gas prices are linked to oil-priced benchmarks.
And then there’s food and beverages, because unless you grow your own produce, it needs to be fertilised using machinery, harvested by tractors and driven places in refrigerated trucks. So expect to pay more at the supermarket and in dining venues.
Oil-driven inflation tends to leak into many different sectors, therefore having a meaningful influence on the broader CPI numbers, even if wage prices don’t increase.
RBA Governor Michele Bullock said inflation expectations were a risk. Picture: Gaye Gerard
What will the RBA do?
The RBA will often choose core over headline inflation when making monetary policy decisions.
Core, or underlying, inflation strips out volatile items like fuel and food. The RBA prefers a wait-and-see approach, especially if it believes volatility to be short-lived.
But while a petrol price shock may be temporary, a prolonged conflict in the Middle East could mean higher energy costs stick around for longer. We have heard that the USA plans to end the conflict in several weeks, but how often does that sort of thing actually happen?
If a two-week war becomes a two-month, or even two-year situation, we could see sustained high oil prices, leading to entrenched inflation as businesses raise prices and employees begin to demand higher wages to stay afloat.
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This would be the RBA’s worst nightmare and would certainly mean the pressure was on to hike rates.
Speaking on Tuesday at an AFR business summit, RBA Governor Michele Bullock showed some concern about the potential for long term inflation expectations to rise.
“With a supply shock occurring, we’re in a situation where we already have high inflation, and I think there is a risk that inflation expectations may start to move,” she said. “That will be front of mind for the RBA board.”
Economist Saul Eslake said some petrol stations may pass on price increases early. Picture: David Killick.
Can oil inflation act like a rate hike?
There is a possibility higher oil prices will prompt consumers to reduce spending, almost doing the work of a rate hike without the RBA needing to make the call.
The RBA may not want to hike rates too aggressively in case it proves too much for the economy. Whether it is forced to hike may depend on other areas of underlying inflation. If they are coming down, the central bank may be able to wait. If not, we may be in for a wild ride, with multiple rate hikes and still-persistent inflation.
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