Bank chief’s big watch on inflation cost of Iran action
Australia’s central bank governor said it was unclear whether US-Israeli attacks on Iran would increase or decrease inflation.
Central Bank governor Michele Bullock said the bank was closely monitoring events in the Middle East but that it would take some time to understand their impact on domestic inflation.
“It’s too early to say what the impact will be. Things are moving quickly and there are different ways this can happen,” he told the Australian Financial Review Business Summit on Tuesday.
“For example, a supply shock could increase inflation pressures. And we are very careful about the potential impacts on inflation expectations.”
“But at the same time, a prolonged impact on energy markets could have negative effects on global economic activity and lead to downward pressure on inflation. It is not clear how this could play out.”
Crude oil prices rose as much as 13 percent on Monday after conflict in Iran, one of the world’s largest oil producers, threatened to cut off supplies from other Middle Eastern countries.
Given oil’s role as an input to the wider economy, there is a danger that the price increase will have a huge impact on global inflation, which is currently running well above the Central Bank’s target.
In a worst-case scenario where the United States is mired in a protracted conflict with Iran and oil supplies are disrupted for longer periods of time, oil prices could double to around $150 a barrel, AMP chief economist Shane Oliver said in a research note.
He attributed a 40 percent probability to such a scenario.
Ms Bullock admitted that the bank had made a mistake in assessing that supply and demand in the economy would come into balance in 2025, which led it to cut interest rates.
The official said he misjudged how strong private demand would be in the second half of 2025 and overestimated the economy’s supply potential.
But Ms Bullock said data released since the Reserve Bank raised interest rates in February supported that decision.
He said labor market indicators remain tight and it is unclear whether financial conditions are restrictive enough to bring inflation back to target in a reasonable period of time.
“We think that most of the unexpected increase in inflation since the middle of last year is due to sector-specific demand and price pressures, which we expect to decrease in the coming quarters,” he said.
“But economy-wide capacity pressures are also playing a role in the economy and we think overall underlying demand in the economy is further away from supply potential than we assessed six months ago.”
The Federal Reserve’s forecast showed that modeling the economy’s direction is difficult enough without geopolitical flashpoints.
Data can send mixed signals.
Ms. Bullock emphasized how murky setting monetary policy can be, noting that hard-to-predict shocks such as the COVID-19 pandemic and global conflicts make it important for the bank to complement its models by listening directly to households and businesses.
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