Reserve Bank interest rates: A Middle East conflagration would pour fuel on cost of living fire

Escalating Middle East tensions pose the threat of renewed cost of living pressure just as the Reserve Bank turns its attention to easing interest rates and boosting the sluggish economy.

Local petrol prices have been tipped to lift 10 to 12 cents amid a devastating war between Israel and Iran — a conflict which could soon broaden as US President Donald Trump weighs up his options.

A temporary price bump would be unlikely to trouble the RBA when it meets next month to set interest rates. The bank’s board prefers to focus on underlying inflation figures which strip out volatility, particularly in fuel and energy costs.

But the central bank would be worried if pain at the bowser pushes up expectations of inflation among consumers and businesses.

That would start to shape behaviour at the shops and in wage negotiations, adding cost pressure back in the economy .

Households are already thinking prices will accelerate modestly, according to recent ANZ data collected in the lead up to aerial strikes between Israel and Iran.

“Escalating geopolitical uncertainty may have led to a rise in weekly inflation expectations as consumers expect an increase in oil prices,” ANZ Economist Sophia Angala said.

A worst-case scenario in the Middle East would add to cost pressure through higher oil prices while also dragging on economic growth.

“Conflict regularly flares up in the Middle East leading to concerns of a threat to inflation and economic growth via a surge in oil prices like in the 1970s and early 1980s,” AMP chief economist Shane Oliver said.

That refers to the “stagflation” era of severe inflation, slow growth, and high unemployment seen following the so-called oil shocks starting in 1973. The crisis was worsened by stimulus from central banks and governments globally.

“Most of the time the fears settle down and the oil supply is not affected,” Dr Oliver said. He said that would most likely be the case now, tipping that oil and fuel prices would settle down within months.

But he acknowledged there was a risk that the latest conflict could turn out to be more serious — with a supply disruption through the crucial Strait of Hormuz between Iran and Qatar sending oil prices rocketing.

The RBA would then need to judge whether the impact is higher costs across the economy or a shake-up of spending behaviour.

“While higher oil prices could add to inflation, it’s more likely to be deflationary as it will act as a tax on spending,” Dr Oliver said.

That’s because consumers and businesses will need to divert cash from other goods and services to fill up their tanks.

The RBA has cut the cash rate twice this year and financial markets are tipping three more moves before December is over.

The United States Federal Reserve is due to meet overnight Wednesday Australian time and was expected to hold interest rates steady at a band of 4.25 per cent to 4.5 per cent.