The Reserve Bank has signalled it will push up interest rates even if the war in Iran delivers a short-term financial hit as a new report predicts Australia will be one of the world’s fastest growing economies with some of the highest inflation this year and next.
Even as the OECD warned central banks may have to cut interest rates if the war drags on and leads to a global slowdown, Reserve Bank assistant governor Christopher Kent said the institution remained concerned that consumers may start to expect ever-higher prices that would help entrench inflation across the economy.
In its first report into the global outlook since the US and Israel war against Iran began, the OECD on Thursday downgraded its outlook for economic growth while increasing its forecasts for inflation.
The Australian economy is forecast to grow by 2.3 per cent this year and 2.4 per cent in 2027. Among the world’s richest nations, only Turkey is expected to grow faster, with Australia eclipsing nations such as the United States (2 per cent this year), the UK (0.7 per cent), Canada (1.2 per cent) and Germany (0.8 per cent).
But that faster growth will come with higher inflation. Australia’s inflation rate is tipped to average 4.1 per cent this year, a 1.4 percentage point increase on what the OECD had forecast late last year, and only second among developed nations to the US (4.2 per cent).
In 2027, inflation is tipped to ease to 2.5 per cent, which would still leave it among the highest alongside nations such as Germany (2.6 per cent) and Mexico (3.2 per cent).
The OECD said that while central banks might have to lift interest rates due to inflation pressures, there was a real risk that if the war continued, banks might have to cut rates as economies slow.
“Faced with the energy price shock, central banks need to remain vigilant and ensure that inflation expectations stay well anchored,” it said.
“Monetary policy adjustments may be needed if price pressures broaden or if growth prospects weaken substantially.”
The organisation’s forecasts are predicated on a gradual drop in oil, gas and fertiliser prices from the middle of the year.
Federal Treasury modelling has found that if oil holds around $US100 a barrel until the middle of the year and then starts falling to its pre-war levels, inflation will probably push to almost 5 per cent by June before gradually easing.
Economic growth would be clipped by 0.2 percentage points in the short term before the economy recovered through the second half of the year.
But if oil averages $US120 a barrel and then takes three years to get back to where it was in mid-February, inflation surges to 5.5 per cent and economic growth would be 0.6 per cent lower this year.
The economy would not recover until at least 2029. High oil prices account for about half of the downturn, while the rest is due to flow-on impacts.
The Reserve Bank, which last week lifted official interest rates for a second successive month and is expected to hike again by June, believes the threat from inflation is greater than a possible economic downturn.
Kent, in a speech in Sydney, made clear the bank is aware that the war will have a larger impact on the economy the longer it continues.
But he stressed the focus at this point remained on inflation and expectations for higher prices among consumers.
“A negative supply shock pushes up prices and leads to weaker economic activity, making us all poorer. Central banks cannot change that,” he said.
“But they can ensure that the initial rise in prices does not lead to a rise in longer term inflationary expectations and extended inflationary pressures.
“We will continue to assess the countervailing forces operating on the economy, including any tightening of financial conditions, or increase in inflation expectations associated with the conflict, so that the board can set monetary policy to achieve low and stable inflation and full employment over the medium term.”
The federal government is under pressure to consider measures to shield consumers and business from the lift in petrol prices caused by the war against Iran. They include suggestions such as axing petrol excise or offering free public transport.
But the OECD cautioned any assistance should be short-lived and aimed at the poorest.
“Government measures to cushion the impact of higher energy prices should be timely, well-targeted on households most in need and viable firms, preserve incentives to lower energy use and have clear expiry mechanisms,” it said.
The organisation also urged governments to improve their budget bottom lines.
“Stronger efforts to contain and reallocate spending, improve public sector efficiency and enhance revenues are required, set within credible medium-term country-specific adjustment paths,” it said.
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Shane Wright is a senior economics correspondent for The Age and The Sydney Morning Herald.Connect via X or email.