The War That Broke the Camel’s Back

The RBA raised interest rates by 25 bps to 4.1%. It was a split decision, with five members of the Board voting for the increase and four voting to leave rates at 3.85%.

Recent data confirmed to the RBA that there is still too much inflationary pressure in the economy. But the war in the Middle East may have pushed the Monetary Policy Board into raising rates now. The longer the war lasts, the worse its impact on Australian and global inflation and economic growth. 

What the RBA’s statement said

“Information since the February meeting suggests that some of the increase in inflation reflects greater capacity pressures.”

“In addition, the conflict in the Middle East has resulted in sharply higher fuel prices, which, if sustained, will add to inflation.”

“As a result, the Board judged that there is a material risk that inflation will remain above target for longer than previously anticipated.”

“There are material uncertainties about the outlook for domestic economic activity and inflation and the extent to which monetary policy is restrictive.”

https://www.rba.gov.au/media-releases/2026/mr-26-08.html

What the governor said at the media conference

“The data we have seen since the February meeting has shown that the economy grew faster than its potential growth rate over the second half of last year. The labour market has tightened a little recently… and underlying inflation remains high. Taken together, the data suggests there is slightly more excess demand in the economy than we thought in February and therefore inflationary pressures are somewhat greater. This is before considering what higher energy prices arising from the conflict in the Middle East could mean for our economy.”  

“Higher petrol prices will add to inflation, but they are not the reason for today’s decision; inflation was already too high, reflecting the fact that demand is outstripping supply.”

“If we do not act, these price pressures will spread, and the eventual adjustment will be harder.”

“We must also ensure that higher inflation does not result in inflation expectations drifting up. Short-term expectations for inflation have moved up a bit, but we need to make sure that this does not translate into higher inflation expectations over the longer term. Longer-run inflation expectations will only remain anchored if people are convinced that we will take action to bring inflation back to target.”

“We had a very robust conversation over the past two days about whether we should hold until May. This would have given us the opportunity to consider more data on inflation and the labour market, and it also perhaps would have provided more clarity on the conflict in the Middle East.”

“But the discussion was very much focused on the timing of a rate increase, all members agreed that another increase was needed…”

“Maybe it was prudent to wait another few months, seven weeks to the next meeting, and see”

“I couldn’t answer the hypothetical question of what we would have done in the absence of the war. What I can say is that certainly it heightened our concerns about inflation on an ongoing sense.”

“At the moment we are not certain how restrictive financial conditions are, and part of that , as I have said, is that inflation is so high.”

“We are trying to bring excess demand down without giving up a lot of the gains in the labour market.”

Domestic inflationary pressure: even more than thought

From December last year, as inflation proved less than temporary, excess demand pushing up inflation emerged as the RBA’s main narrative.

However, it seems that at every Monetary Policy Board meeting since, the strength of that excess demand keeps surprising the RBA.

“... the data suggests there is slightly more excess demand in the economy than we thought in February and therefore inflationary pressures are somewhat greater.” Michele Bullock, RBA governor, Monetary Policy Decision Media Conference, 17 March 2026.

December quarter GDP figures were released earlier in the month and surprised on the upside with 2.6% versus an expected 2.3% annually. It was also the fastest rate of growth since March 2023 (see chart below). Private and public demand contributed equally to the strong result for the quarter.

On top of the strong growth result, the labour market remains tight and, as Bullock said at the media conference, it may have even tightened. The Wage Price Index increased from 3.3% in the September quarter to 3.4% in the December quarter. It is heading in the wrong direction! Unemployment remained at a low 4.1% in January on a seasonally adjusted basis.    

Given these results, it would not have been a surprise to the RBA to see its preferred inflation measure, trimmed-mean inflation, rise from 3.3% in December to 3.4% in January on an annual basis (see chart below).

It was thus unsurprising that the RBA raised rates. However, the 5-4 split in the Board’s vote shows it was not a foregone conclusion. From Bullock’s comments at the media conference, it seemed that while all members were inclined towards a hike, some wanted to wait for ‌more data and pull the trigger in May. To me, this sounds like the natural conservatism of the RBA shining through and its preference for quarterly inflation data over the new monthly series. Of the Board’s nine members, only two are Bank staff.

Going forward, it would seem unlikely that the RBA can keep being surprised by the strength of domestic demand. Either the war will slow the Australian economy down, or current and future rate rises will. The seven weeks until the next meeting will be instructive on both counts.   

Keeping inflation expectations anchored

As inflation has increased again, so of course have consumers’ inflation expectations. The latest result from the Melbourne Institute showed an increase to 5.2% - the highest level since July 2023 (see chart below). Bullock noted the increase at her media conference.

“Short-term expectations for inflation have moved up a bit, but we need to make sure that this does not translate into higher inflation expectations over the longer term.” Michele Bullock.

For central banks, rising inflation expectations are just as bad, if not worse than, rising inflation because rising expectations can create a self-fulfilling prophecy. If expectations keep rising, so will the odds of further rate rises.

Source: tradingeconomics.com

The war is increasing inflationary pressures 

Petrol pumps across Australia already show that the war is having an inflationary impact (see chart below).

The RBA can write off the initial inflation impact of the war as temporary. But the longer it goes on, the higher the likelihood that higher petrol, fertiliser, and LNG prices will push up prices more generally as businesses look to recoup costs. The second-order inflation impact could be widespread across the economy.

Further, there is nothing like raising petrol prices to push up consumer inflation expectations. It would be a headache for the RBA if rising inflation from the second-order effects then met these expectations. At that point, the anchor of inflation expectations may be rising like a balloon!

The good news is that the war will likely end soon if rationality prevails. Unfortunately, the logic of the deal prevails over economic rationality in the current White House.   

Australian Private Debt Market

The rise in the interest rate is a sign that the Australian economy is performing strongly and, unlike in the US, where concerns over employment are growing, no one is talking about stagflation here. As the rise in the Australian dollar has shown, Australia is emerging as a safe haven in the current environment — one that is particularly favourable for private debt, where strong economic fundamentals underpin borrower quality and consistent returns.