Middle East war set to push inflation higher than forecast, warns RBA deputy governor

The Reserve Bank’s Deputy Governor Andrew Hauser says inflation in Australia looks likely to be higher than projected before the war in the Middle East broke out.

The Reserve Bank’s board will meet to discuss interest rates next week. Reserve Bank Governor Michele Bullock has flagged the meeting will be “live” – meaning there could be a change in interest rates announced on Tuesday.

Global oil prices have seen a dramatic spike then fall this week, creating major uncertainty for the international and Australian economies.

Speaking on the Politics with Michelle Grattan podcast, Hauser concedes the bank’s projection for headline inflation for June – an annual rate of 4.2% – is likely to be exceeded because of surging oil prices and other fallout from the Middle East war. Inflation is already well outside the bank’s 2-3% target range.

Hauser won’t put a number on the likely mid-year level, but downplays the prospect of it reaching 5% by then, as NAB’s chief economist Sally Auld has suggested. Hauser says:

That 5% I think assumes that the oil price is in the sort of US$100 range, which we were well into yesterday, but not into today. We don’t have updated numbers on our forecast now. We don’t actually formally update our forecast until May, which is the [board] meeting after the one coming up.

[…] But it clearly is the case that it’s an upside risk to that projection in February. It’s still in flux […] I don’t want to give a number that might give a false sense of accuracy. But certainly directionally it’s higher than the projection we published in February.

The outlook for interest rates

Asked whether the fallout from the Middle East conflict makes an imminent rate rise more or less likely, Hauser says: “there’s going to be a lot for the board to discuss next week”.

I think there’ll be a very genuine debate. Inflation is too high. Higher prices don’t help that debate. But there are arguments from both sides, and I think if ever there was a time when board members will earn their meagre salary, it’ll be this month.

On what home owners and buyers can expect over the next year, Hauser says:

What I do hope we’ll be able to show is that we have brought inflation back down into, or close to, the target range; that employment has remained close to full employment; and growth has held up. I will be very happy indeed if we manage to get those macroeconomic outcomes.

[…] I’m afraid to say that what path of interest rates is required to get us to that outcome is less certain. It’s always less certain than the outcomes we’re targeting, and it’s probably a bit less certain still against the backdrop of the developments [in the Middle East]. And to be honest with you, I’d be lying if I told you otherwise. So what I hope we will be able to say [in a year] is that we have delivered on our macroeconomic mandate, and that interest rates are on a sensible path back to normality.

Reining in ‘toxic’ inflation

Hauser points out there are a number of “offsetting factors” as the board considers reining in inflation.

It’s worth us continuously reminding ourselves just how toxic inflation is. We’ve only just had an experience of that and we don’t want to go through that period again.

But he says “the Australian economy, in many ways, is in good shape”.

Growth has recovered quite materially over the past year. Unemployment is close to historic lows and compares very favourably internationally. And average levels of wealth and income in the economy are pretty good by international comparisons. But we have a problem with inflation. It’s too high.

The rise of AI in Australia

Hauser has just flown in from the United States, and says artificial intelligence (AI) remains the dominant topic of conversation in economic circles there.

Of the many conversations I had in the US when I was out there, fully 80% to 85% of them were dominated by discussions about AI. What was it going to do to employment in the US? How is it going to change the organisation of companies? How is it going to drive productivity growth? What was it going to do to social cohesion?

While Hauser says Australia is “not at the same level of advancement” or “maturity” in adopting AI as in the United States, he remains confident that Australia stands to benefit from AI overall.

Australia has time and again shown an incredible capacity to harness technologies and its natural raw material strengths and its national ingenuity and human capital to profit, frankly, or to benefit from challenges in the global economy. And, secretly, I am more optimistic than many people I speak to here that Australia might pull that off again.