Quick Bites | RBA Walking a Fine Line

Central banks are focused on pricing money to promote employment and price stability. On the latter, when inflation is being driven by demand factors (i.e. a strong economy growing ahead of its “natural” rate), the decision to hike rates isn’t contentious. But what happens when inflation is being influenced by supply-side factors? Spiking oil prices have introduced a cross current into the policy rate outlook. The RBA must judge whether inflation from an oil shock is a temporary impact that can be ignored or a catalyst for broader inflation that requires further tightening.

Source: IFM Investors

Because economies are complex and dynamic, there isn’t much to glean from history how central banks behave when oil spikes and creates an inflation impost. For example, the 1979 oil shock saw the world’s most consequential central bank, the US Federal Reserve, raise policy rates, as it did during the 1990-91 Persian Gulf War. But then recall 2008, when oil reached almost US$150 per barrel, but the Fed cut rates given the events of the GFC. Another similar event happened last year when the US implemented tariffs (which like an oil shock results in higher prices and weaker growth), but which did not change the Fed’s course of reducing policy rates through the year.

If there was one observation from history worthy of mention, it’s that spiking oil prices aren’t any more damaging to growth than historically. An article from the Australian Bureau of Statistics in 2021 noted that automotive fuel in the CPI basket has fluctuated between 2% and 5% since its inclusion in the CPI calculation in 1948. Most recently, automotive fuel had a weighting of 3.4% in the CPI basket for 2025 (from 3.7% in 2024). Hence, absent oil escalating to unprecedented levels, it’s unlikely the current spike will be any more detrimental to inflation and growth than observed in the past.

Given inflation from oil is a headwind to growth, why have some economists tipped a rate rise next week? Won’t a rate rise on top of a spike in petrol prices act as a double whammy for the economy? If recent share market movements are any guide, the outlook for retailers has turned bleak.

Much as the RBA already had its finger on the rate hike trigger before the Iran invasion given elevated inflation of 3.8% (and the RBA was the only developed world central bank to have hiked rates in 2025 – apart from Japan which is a special case), it needs to be careful that the self-tightening already underway from oil could mean further increases in the policy rate prove excessive. Put another way, while the RBA must remain vigilant about the persistence of inflation expectations, it also needs to ensure that additional tightening does not unnecessarily weaken labour markets.