The crisis in the Middle East fanned the flames of already buoyant inflation in Australia and could lead to more interest rate pain if it isn’t resolved, the central bank has warned.
The Reserve Bank of Australia released fresh quarterly economic forecasts on Tuesday, when it simultaneously raised its key cash rate by 25 percentage points to 4.35 per cent, as was widely expected.
The rate hike means further repayment pain ahead for mortgage and business loan holders, even as risk continues to lie toward further hikes later this year.
The May quarter forecasts, produced by central bank staff, show the economy is set to slow and consumer price inflation is heading up, although unemployment is likely to remain little changed until the end of the 2026.
“Prior to the conflict in the Middle East, inflation in Australia was materially above target, and the economy and labour market were operating with ongoing capacity pressures,” the RBA said.
“The conflict has led to sharp increases in commodity prices, particularly energy, which has pushed inflation higher.”
The RBA acknowledged that financial markets are currently assuming the central bank’s cash rate will rise to 4.70 per cent by the end of 2026.
This is in line with its use of market cash rate pricing as its base case assumption to inform its modelling for the broader economy.
“Given uncertainty around the duration and severity of the conflict, the outlook for inflation and economic conditions is more uncertain than usual,” it said.
The RBA’s base case is for inflation to remain above its two to three per cent target band for some time.
Headline inflation is expected to rise to an annualised 4.8 per cent in June, before potentially easing to four per cent in December.
The bank’s preferred underlying, or core, inflation measure is on track to 3.8 per cent in June before dipping to 3.5 per cent in December.
The latest data, for the month of March, from the statistics bureau had the measures running at 4.6 per cent and 3.3 per cent, respectively.
On the economy, the RBA sees spending slowing in the months ahead as essentials like higher fuel costs continue to bite.
“These effects will be greater if the Middle East conflict is prolonged, but the global environment is unpredictable,” it said.
Gross domestic product growth is forecast to fall to 1.9 per cent in the year ended June and then to 1.3 per cent in December.
In the 2025 December quarter – the last set of growth data available – the economy lifted to 2.6 per cent.
Turning to the labour market, things get a little complicated because if spending continues to fall, it could prompt job losses.
“If uncertainty becomes particularly high, households and businesses could cut their spending by much more, which would mitigate some of the increase in inflation but lead to a higher unemployment rate,” the RBA warned.
The RBA’s base case is for the unemployment rate to dip to 4.2 per cent in June before bumping back to 4.3 per cent in December.
Overall, the RBA doesn’t see core inflation falling back to the middle of its target band until June 2028.
The federal government will reveal its forecasts in the May 12 budget.
Australian Associated Press is the beating heart of Australian news. AAP is Australia’s only independent national newswire and has been delivering accurate, reliable and fast news content to the media industry, government and corporate sector for 85 years. We keep Australia informed.
