Document
Oil Shock Looms Large: Shadow Board Supports Further Rate Rise
Australia’s inflation picture has deteriorated again. The monthly CPI indicator rose 4.6% over the year to March, up from 3.7% in February, while trimmed-mean inflation remained at 3.3%. The quarterly figures were also uncomfortably strong: the CPI rose 1.4% in the March quarter and 4.1% over the year, while quarterly trimmed-mean inflation increased 0.8% in the quarter and 3.5% over the year. Both headline and underlying inflation are therefore clearly above the Reserve Bank’s 2–3% target band. Housing and transport were the main contributors, with automotive fuel prices surging in March as the Iran war and the disruption around the Middle East pushed oil prices sharply higher, noting that the March reading preceded the 1 April halving of the fuel excise. At the same time, the unemployment rate has risen only gradually, to 4.3%. This leaves the policy mix in an awkward position ahead of the 2026–27 federal budget, to be delivered on 12 May. Treasurer Chalmers has emphasised savings, productivity and tax reform, but until the budget is known it remains unclear whether fiscal policy will materially assist disinflation or instead cushion demand in a way that complicates the RBA’s task. Against this background, the RBA Shadow Board recommends the cash rate be raised, attaching a 71% probability that raising the rate above 4.10% is warranted.
In March, the seasonally adjusted unemployment rate edged up to 4.3%, while the participation rate slipped to 66.8%. Employment still increased by about 18,000, driven by a 52,500 rise in full-time jobs that more than offset a fall of 34,600 in part-time employment. Underemployment was 5.9% and monthly hours worked rose to 2,016 million. New data on quarterly wage growth will only be published next week. Job vacancies increased by 2.7% in the February quarter to 337,900, although they remain well below the 2022 peak, while ANZ-Indeed job ads fell 3.1% in March after a strong February increase. Taken together, these data suggest that labour demand is easing, but only slowly. That matters for monetary policy because an inflation shock driven initially by fuel and freight becomes more troublesome if the labour market remains tight enough to support pass-through into wages and broader services prices.
The Australian dollar finished the week near US$0.72, stronger than earlier in the year. In sovereign debt markets, yields have shifted higher across the curve: the 1-year and 2-year Australian government bond yields are both around 4.70%, the 5-year yield is around 4.75%, and the 10-year yield is close to 5.0%. The curve is therefore essentially flat at the very short end but clearly upward sloping further out. That is more consistent with a higher-for-longer policy outlook than with an imminent and smooth easing cycle. Equity prices have been more unsettled. The ASX200 recovered some ground late in the week, but the market still finished the week down 0.6% overall. The main market message seems to be that investors have become less confident that the recent inflation overshoot will prove short-lived.
Household-sector indicators present a mixed but increasingly uncomfortable picture. Consumer confidence fell sharply in April, with the Westpac–Melbourne Institute Consumer Sentiment Index dropping 12.5% to 80.1, the largest one-month fall since the pandemic. The most pronounced declines were in assessments of family finances and the near-term economic outlook, which is consistent with the renewed squeeze from higher petrol prices, mortgage stress and resurgent inflation worries. The weakened consumer sentiment is not matched by comparably weakened spending data, however. The ABS Monthly Household Spending Indicator rose 0.3% in February and was 4.6% higher than a year earlier, with discretionary spending up 0.5% over the month. Credit growth also remained firm in March: total private credit rose 0.7% in the month, housing credit 0.6% and business credit 0.8%. The discrepancy between soft sentiment and resilient spending makes it difficult for the RBA to gauge whether household spending will hold up in the future.
Business surveys tell a similar story of softer confidence but renewed cost pressure. NAB’s March survey showed business confidence collapsing by 29 points to -29, one of the sharpest monthly falls on record, although business conditions remained positive at +6 and capacity utilisation stayed high at 83.1%. Forward orders slipped back into negative territory. More troubling for the inflation outlook, purchase-cost growth accelerated to a 3.0% quarterly-equivalent pace and final-product price growth rose to 1.1%, suggesting that higher fuel and freight costs are beginning to move through the pipeline. The April flash PMI readings were slightly less bleak on activity than the March numbers: the composite index recovered to 50.1, services to 50.3 and manufacturing to 51.0. Even so, the survey detail pointed to the fastest increase in input costs since 2022, with firms explicitly citing higher fuel bills, shipping disruption and supply-chain delays linked to the Middle East conflict. In short, the business-sector data describe an economy hit by a stagflationary shock: weaker confidence and slower momentum, but also higher costs and more difficult inflation dynamics.
The international backdrop has worsened since the IMF’s April 2026 World Economic Outlook. The Fund still projects global growth of 3.1% in 2026 and 3.2% in 2027, but that baseline assumes that the war-related disruption remains limited and temporary. The OECD is somewhat more cautious, forecasting global growth of 2.9% in 2026 and warning that G20 inflation will be materially higher than previously expected, at 4.0% this year, if energy prices and tighter financial conditions persist. The World Bank’s latest Commodity Markets Outlook expects energy prices to rise by 24% in 2026, with Brent crude averaging about US$86 per barrel in its baseline, but US$95–115 if disruption through the Strait of Hormuz proves more prolonged. Kristalina Georgieva, the International Monetary Fund’s managing director, has offered a simple rule of thumb: a persistent 10% increase in oil prices adds around 0.4 percentage points to global headline inflation and subtracts 0.1–0.2 percentage points from world output. For Australia, that is a difficult combination. Higher energy prices can support income through commodity channels, but the near-term effect is to raise fuel, freight and other tradables costs, while weaker global growth would soften external demand.
After the rate rise in the last round, the Shadow Board assigns a 27% probability that holding the overnight rate at 4.10% is optimal, a 2% probability that reducing the overnight rate back to 3.85% is appropriate, and a 71% probability that raising the rate above 4.10% is warranted. The mode recommendation is for an increase of 25 basis points to 4.35%. The Shadow Board’s perceived inflation risks continue to be revised to the upside.
Six months out, the Board attaches a 15% probability that the cash rate should be lower than the current setting of 4.10%, a 17% probability that the current setting is optimal, and a 70% probability that a higher rate is required. The mode (with a confidence probability of 24%) is for the overnight right to be set to 4.60%. At the 12-month horizon, probabilities are 27% for a lower interest rate, 16% for a rate hold, and 57% for a higher rate. Three years out, the Board attaches a 67% probability of a lower rate being optimal, 11% to the current setting, and 22% to a higher rate.
The distribution for the current recommendation widened, and moved up, by 25 basis points, to 3.85%–5.10%. For the 6-month horizon, the distribution shifted up to 3.85%–5.35%. The same applies to the distribution for the 12-month and 3-year horizons, each with a range of 0.60%–5.35%.
