The RBA's chief economist has warned Aussie households may have to ride out further rate hikes and rising unemployment as tensions in the Middle East reignite.
Speaking in Canberra on Wednesday, RBA assistant governor Sarah Hunter said the bank faces an unavoidable “trade-off” in how it manages its priorities – one that will continue to place pressure on the rising cost of living.
It comes amid United States military confirmation that new strikes have been launched on Iran this week following alleged attacks on civilian-crewed vessels in the Strait of Hormuz.
The effect on global supply chains continues to grow, with oil prices jumping around 6% on the news.
In RBA language, the war is considered a supply shock for the economy. The question is whether these 'shocks' are temporary, or persistent, which can determine the path for inflation.
"If people expect the shock to be over quickly, they are less likely to respond to it," Ms Hunter said.
"By contrast, if the shock is expected to be more persistent, it is likely to have larger impacts and create greater risks of inflation expectations shifting."
RBA chief economist Sarah Hunter says the central bank is balancing its priorities. Picture: NewsWire/Martin Ollman
She said that while any supply shock will naturally create a trade-off for monetary policy and the economy, the frequency of shocks had increased.
“These shocks appear to be becoming more frequent [and] that means the RBA – and the economy more broadly – may have to face these trade-offs, and the costs that come with them, more often in the years ahead.”
Australians have felt the pinch of three rate hikes so far this year, taking the cash rate from 3.60% to a two-year high of 4.35%. Despite this, Ms Hunter said the tightening is not enough to withstand the domestic economy against issues overseas.
“Economic spillovers from rising geopolitical tensions, trade fragmentation, and the increasing prevalence of extreme climate events are just some of the shocks we are now experiencing,” she said.
“As a small open economy, we are buffeted by changes in the global environment.
“Monetary policy is a demand management tool. We can’t use it to materially change the economy’s trend rate of productivity growth or maximum sustainable employment."
The Reserve Bank has raised interest rates three times this year. Picture: Getty
Instead, the RBA is facing a delicate balance act in its dual mandate to achieve both low and stable inflation, and full employment.
“Some types of economic disturbances, or shocks, will put our mandate outcomes into conflict by pushing up inflation while also weighing on demand and activity,” Ms Hunter said.
“Supply or relative price shocks can create a trade-off for monetary policymakers if they are likely to have a persistent impact on inflation and the broader economy.”
All else equal, Ms Hunter said a persistently higher outlook for inflation “suggests that interest rates should be raised”.
“But at the same time, weaker economic activity and so more excess supply suggests that interest rates should be cut,” she countered.
Ms Hunter billed this as a trade-off that “cannot be avoided”, raising questions as to just how much further forecasts will need to be adjusted if the Iran War continues much longer.
Current expectations from both the central bank and the Treasury already have underlying inflation only returning into the 2-3% low and stable inflation target range by late 2028.
With a month left until the RBA’s next cash rate decision however, markets are only pricing in a 19% chance of a fourth rate hike.
“A central bank can only decide how to balance the impact on inflation and activity, while ensuring that temporary shocks do not become persistent inflation,” Ms Hunter said.
While supply shocks are creating challenging trade-offs for the RBA, Ms Hunter reiterated they “do not lessen the importance of maintaining low and stable inflation”.
“The board will continue to act as needed to ensure inflation returns to target and the labour market to sustainable full employment,” she added.
The next cash rate decision will be on 11 August.
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