The major shock is fuel prices. Fuel prices have a direct impact on the price of transport. They also raise the costs of business throughout the chains of supply. This can permeate food, services, retail prices and wages. The RBA pointed out that increases in fuel prices are also contributing to inflation and can have second round effects. That’s why the May rate increase wasn’t simply in response to one data point. This was done to prevent the temporary inflation in energy prices from becoming a broader inflation issue.
Oil Prices and Strait of Hormuz Risk Shape the June Outlook
Now the outlook is uncertain regarding the rate and depends on the Strait of Hormuz. If the Strait remains closed and oil prices remain above $100, the inflation may surge to 5%. That would put additional strains on the RBA to maintain high rates. If the war heats up and oil prices rise, the RBA will likely be forced to hike rates. If the war cools down and oil prices retreat, the RBA might pause and wait for earlier rate hikes to curb demand.
This view is already reflected in market prices. In the wake of the decision, the Australian dollar was seen edging slightly lower and bond yields for three years tumbled as markets wagered on the chances of a further interest rate increase being unlikely. The response to this increase in May was construed as hawkish but not necessarily the beginning of new aggressive cycle. The swaps suggest that there is only slight risk that it will rise again in June.
Australia’s Economy Faces Pressure From Higher Rates and Oil Prices
Weak Growth Limits the RBA’s Room for More Tightening
The RBA is in a tight situation. Inflation is too high while growth is beginning to weaken. This makes the interest rate outlook more complicated than normal tightening cycle. The central bank needs to tame inflation without aggravating the economic slowdown further.
The economy is still expanding but only slightly. The S&P Global Australia Composite PMI bounced back to 50.4 in April up from 46.6 in March.
