Reserve Bank bracing for inflation to hit 5 per cent by June 2026, fears higher oil prices will hit economy

The Reserve Bank is bracing for inflation to soar to 5 per cent by June for the first time in three years as a result of crude oil prices remaining at $US100 a barrel, the minutes of this month’s meeting have revealed.

Despite a close vote, RBA monetary policy board members were nervous about consistently higher oil prices feeding through to other parts of the economy when they raised the cash rate by another 25 basis points to 4.1 per cent on March 17.

The RBA is worried that headline inflation will hit 5 per cent an on annual basis by June, reaching levels last seen in the September quarter of 2023 during its last period of aggressive hikes.

This would have the consumer price index at a level 0.75 percentage points higher than its February forecast, made less than a month before the US strikes on Iran sparked a wider conflict in the Middle East and a blockade of the Strait of Hormuz.

“Sustained higher oil prices would also boost inflation more broadly over time as input costs for firms rose and some of this effect was passed onto consumers,” the Reserve Bank said.

“Members noted that, consistent with this analysis, short-term inflation expectations had increased further following the onset of the current conflict.”

The Reserve Bank’s fears about near-term inflation are even more dire than Treasury modelling, which sees the 5 per cent inflation level being reached in the next financial year, with motorists now typically paying more than $2.50 a litre for unleaded petrol.

“Higher petrol prices would flow through directly to headline inflation in Australia (and globally) in the near term,” the RBA minutes said.

“While a full update of the forecasts had not yet been prepared, the staff shared a simple estimate that the direct effect (via petrol prices) of oil prices remaining around US$100 per barrel would on its own lift headline inflation in Australia to around five per cent over the year to the June quarter, around three-quarters of a percentage point higher than had been expected in February.”

Despite the inflation threat, the vote was close with five members of the RBA’s monetary policy board opting to raise rates as four chose to keep them on hold.

In a sign of tension, the board appeared to be divided on whether to focus more on the headline or underlying levels of inflation, without volatile items, in light of the worst global oil shock since the 1970s.

“Members discussed why markets did not expect most central banks to look through the supply shock emanating from the conflict,” the minutes said.

“They noted that this was more difficult to do when the shock was expected to be large and inflation had been above target for some time (as was the case in many economies).”

The Commonwealth Bank, Australia’s biggest home lender, is warning of higher food prices as a result of higher diesel prices.

“Since the beginning of the US‑Iran conflict, prices of Australian commodities have followed offshore markets higher,” agricultural economist Dennis Voznesenski said.

“If the Strait of Hormuz remains closed, and the cost of farming elevated, it could lead to reduced production globally and higher prices for consumers.”

The futures market regards a rate hike on May 5 as a 67 per cent chance but ANZ’s head of Australian economics Adam Boyton said a sizeable minority of RBA monetary policy board members could potentially be hesitant to raise rates as they assessed the effects of an economic slowdown.

“We take the minutes as suggesting that the May meeting starts as a ‘clean-slate’, that is, there are not four members heading into that meeting opposed to a further rate hike,” he said.

“The lack of forward guidance also suggests that the board does not have a pre-conceived view on a likely path for the cash rate.”

A May hike would mark the third increase since February and cancel out the RBA’s three rate cuts in 2025.

Even more pain is expected, with the 30-day interbank futures market pricing in three more hikes in 2026 that would take the RBA cash rate to an 18-year high of 4.85 per cent, reaching levels last seen during the Global Financial Crisis.

Despite the threat of a slowing economy, the RBA minute suggested board members were more focused on existing tightness in the labour market with the meeting occurring before new Australian Bureau of Statistics data showed unemployment in February had edged up to 4.3 per cent from 4.1 per cent in January.

“Members noted that several indicators suggested that labour market conditions in Australia may have tightened a little since the previous meeting,” the minutes said.

But Treasurer Jim Chalmers insisted the RBA was still focused on its dual mandate of maintaining full employment and aiming to return inflation back to its 2-3 per cent target, from an already-high 3.7 per cent level in February before the Iran war.

“Central banks around the world, including here in Australia, will weigh up the likely consequences for inflation and growth and unemployment in all of the usual ways,” he told reporters in Canberra.

He added a temporary, three-month halving of fuel excise to 26.3 cents a litre, from April 1, would take at least a week to flow through at the bowser, given the tax is levied at a wholesale level.

“It is about the replenishing of the stocks in the tanks. The fuel in the tanks right now he been purchased at the higher rate and so people should expect it would take somewhere between maybe one and two weeks for the full benefit of the excise to flow through,” Dr Chalmers said.

“I don’t think market expectations for interest rates changed much yesterday after the announcement of our policy.”