Middle East war "ignites" inflation, will the Australian Reserve Bank raise interest rates again on Tuesday?

Notice that when the Reserve Bank of Australia holds its second interest rate decision meeting of the year this week, the committee will find that the current inflation problem is further deteriorating due to the energy price shock caused by the Middle East conflict. Economists predict that due to concerns that soaring oil prices will push up consumer prices, the RBA will announce a second consecutive rate hike on Tuesday afternoon at 2:30 Sydney time, raising the cash rate to 4.1%. The money market currently expects a two-thirds chance of a rate hike in March and believes there will be more tightening measures in the future. Nick Stanza, an economist at the US Bank, said, "The Iran conflict introduces significant inflationary risks, and our current estimates show that overall inflation will approach 5%," while the central bank's inflation target range midpoint is 2-3%. Stanza pointed out that given the current trajectory of price pressures and the tight labor market, the RBA has "limited room" to ignore this shock. He stated that if there is no rate hike in March, "there will be an increased risk of more destructive tightening in the future, as 'higher and longer' inflation expectations will be rooted in the public's consciousness." The driving force behind rate hike expectations mainly comes from the escalating conflict in the Middle East. Previously, Iran responded to US airstrikes by attacking energy-rich Gulf countries. Oil prices skyrocketed, battles disrupted air travel and the flow of goods such as fertilizers, while the RBA is already anxious about inflation. Traders expect that the cash rate will reach its highest level since 2011 by the end of this year. On Sunday, Treasurer Jim Chalmers said that households may face increased cost of living pressures and warned that the inflation rate is likely to rise above 4.5%. Chalmers said in an interview, "We have run several scenario analyses based on realistic assumptions about global oil prices and their duration on potential inflation impacts," "If we lock in these forecasts today, the peak of inflation is projected to be between 4.5% and 4.9%." Last month, the RBA became the first major central bank in the developed world to tighten policy this year, reflecting its concern that inflation could become entrenched if policy settings were not sufficiently restrictive. Since that meeting, deepening threats of the Iran war have further decoupled inflation expectations. In February, the RBA predicted that CPI would peak at 4.2% this year, based on technical assumptions of crude oil prices at $63.8 per barrel until 2028 and the cash rate at 4.2% in December. Most economists expect further rate hikes in May, pushing the cash rate to 4.35%. The last time the RBA raised rates three times in a row was from April to June 2023. Governor Michelle Brock's news conference an hour after Tuesday's announcement will be closely watched for clues about the outlook. However, the decision is not without suspense. Some economists who insist on action in May point out that by then the RBA will have quarterly inflation data and updated internal forecasts. Last week, Deputy Governor Andrew Hauser outlined the challenges facing Australian policymakers. Before the outbreak of the war, the RBA expected inflation to return to near the midpoint of the target range within a few years. Hauser said the key issue is how recent data from domestic and global sources will change this scenario. Recent data show upward risks: - January inflation rate: in line with expectations, but well above the target. - Consumer inflation expectations: a private measure for March rose to 5.2%, the highest level since July 2023. - GDP growth: last quarter's annual growth rate was 2.6%, exceeding the RBA's estimate of sustainable economic growth of about 2%. - Capacity utilization: remained high, indicating that demand exceeds the economy's supply capacity. - Unemployment rate: maintained at a very low level of 4.1%. - Labor demand: recruitment ads and other measures have strengthened. Hauser pointed out that in this context, any additional price pressure from rising energy costs is "not a favorable development" for decision-makers. Nevertheless, the debate is not one-sided. Some economists, including Lucy Ellis from West The Pacific Bank (former senior official of the RBA), expect dissenting votes on Tuesday after a series of consistent decisions. The uncertainty of the Middle East situation remains high, and if the conflict persists, it could drag down global activity, posing a clear downside risk. If the Strait of Hormuz, which connects the Persian Gulf to the world market and carries about a fifth of global oil flows, is closed for three months, oil prices could soar to $164 per barrel. Although high oil prices will push up overall inflation in the short term, they will also squeeze household incomes and suppress consumption. If the conflict escalates, the global financial environment could tighten, leading to chain reactions that hit business confidence and export demand. Domestic data also present contradictory features: consumer spending growth is weaker than expected, and wage growth remains within manageable limits. Therefore, the committee will weigh the two existing risks: doing too little leading to higher inflation expectations, or hiking rates in a fragile global environment leading to a sudden halt in local economic growth and higher unemployment. Diana Muhina, Deputy Chief Economist at Asset Security Capital, said that these uncertainties create a difficult response mechanism for the RBA. Although she also predicts a rate hike this week, she believes a better choice for decision-makers would be to wait. "I don't think central banks should act quickly in the current environment: this is a supply shock, and we face risks that could slow growth," Muhina said. "I would like to know if the RBA would hike in March without the outbreak of the Middle East war, and the answer is probably no." Her view is supported by other major central banks convening this week, including the European Central Bank, the Federal Reserve, and the Bank of Japan, all expected not to raise borrowing costs.