Danger zone: why war in the Middle East has landed the RBA’s inflation fight in tricky territory

The fight against inflation has entered a new, more dangerous phase.

For years, the Reserve Bank has been attempting, as gently as possible, to steer inflation back to its 2.5% target while trying to retain as many of the post-pandemic job gains as possible.

“That still remains the strategy,” Michele Bullock, the RBA’s governor, told journalists on Tuesday afternoon, an hour after the board announced the fourth interest rate hike for the year.

Unemployment has climbed by 1 percentage point over the past four years, sure, but at 4.6% it’s “still quite low historically,” Bullock said.

Other central banks have managed to get inflation lower, sure, but at the cost of higher unemployment, she said.

Yet there are signs that the central bank may be losing faith in this “slowly, slowly” strategy.

Bullock explained the RBA has been outside the 2-3% target range for six years now. That’s a problem, because households and businesses need to believe that inflation will fall again, one day.

“We came in [to the range] briefly in 2025, and then we’ve popped back out again. We are aiming to get it back,” she said.

But how to get inflation back under control “in a reasonable time”, when unreasonable things keep happening?

It’s the unending Middle East conflict that now looms as the biggest threat to the RBA’s careful approach to taming inflation.

As Bullock said: “When the Middle East conflict first started, everyone was sort of thinking, ‘Oh, it will probably not last very long’.”

“Well, that’s clearly not true. It’s lasted, and there doesn’t seem to be any end to it,” she said.

Fuel prices, fertiliser prices, transport prices are now all “permanently higher”.

“So this idea that they would go up and then come down again just hasn’t happened.”

The RBA governor is worried that businesses are also coming to the same conclusion, and will start lifting their prices. That will make it even harder to get inflation back to target without a more dramatic increase in interest rates.

Bullock and her board have long made it clear they will “do what it takes” to get inflation back to target, a phrase they repeated on Tuesday.

After Tuesday’s announcement, a number of economists are betting the RBA will hike again in six weeks’ time, at the Melbourne Cup day meeting. Financial markets see a 50% chance of yet another increase next year.

All up, it sounds like the RBA is ready to start pushing harder against inflation.

That might be the right call, but it increases the risk the central bank will push too hard and, in Bullock’s words, drive the economy into a “dramatic slowdown”.

“Hopefully, in the next couple of years, when we get inflation back down, this will have all been worth it.”