Next week’s Reserve Bank of Australia (RBA) Monetary Policy Board will undoubtedly be an extremely fine judgement.
There are risks both ways.
Failing to confront an inflation surge is replete with risk. Inflation expectations could become unanchored and ultimately self-fulfilling. That was true even before the spike in oil prices induced by the Middle East conflict.
On the flipside, there is an argument that any tightening of monetary policy, combined with the activity diminishing consequences of an elevated oil price, risks tipping the economy into recession, which might ultimately correct any initial or temporary inflationary consequences. Indeed, there is a body of opinion that asserts that an elevated oil price is ultimately disinflationary because of the diminishing activity effects.
The RBA has been “patient” through the post-COVID tightening cycle and also through the easing period.
There is an argument that the RBA strategy has been successful, given the relatively low unemployment rate in Australia compared to other developed economies.
The downside is that Australia has been visited with a greater inflation rate than its developed country peers and an inflation rate that has been pretty much consistently above the 2-3 per cent target.
The RBA task has had little help from governments, both state and federal.
Governments have, for decades, averted their eyes from any meaningful focus on structural reform (resulting in poor productivity growth) and fiscal policy has not assisted the RBA in its quest to return inflation to target. That has wrought a surfeit of business and labour costs that ultimately found their way into higher prices. In other words, the Australian economy has arguably become possessed of a particular inflation proclivity.
The question that the RBA now needs to address is whether continued prevarication in assuming a more aggressive role in containing inflation will ultimately lead them to having to slam the monetary brakes aggressively in the future and risk a bigger dislocation in activity growth and the labour market. That was the lesson from the 1970s.
I am not suggesting that the current circumstance is anywhere near quantitatively on a par with the stagflation of the 1970s. But some elements are redolent of that time, albeit on a substantially reduced scale – “stagflation-lite” if you will.
As to the argument that a surge in oil prices is ultimately disinflationary, I have my doubts.
That may have been true through the 1990s and into the early 2000s, when there were a number of structural forces suppressing inflation.
It is less true in 2026.
The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures; domestic regulation of goods and labour markets is increasing in scope leading to loss of flexibility in markets and attendant upward price pressures or “sticky” inflation”; and baby boomer workforce participation is declining (limiting labour supply and lifting wages).
What the foregoing means is that central banks need to be more attuned to inflation risks now more so than at any other time since the 1980s.
That has particular relevance in Australia given its inflation proclivity.
If patience is not prudent, then a March rate hike is on the cards.
US CPI and the Fed: the door is ever so slightly ajar…but the Fed won’t walk through in March
The Fed faces a somewhat different decision than the RBA.
In the absence of the sharp rise in oil prices, there would be an argument that the subdued February payrolls report released last Friday and a “benign enough” February consumer price index (CPI) report released overnight leave the door ever so slightly ajar for the Fed to cut the policy rate when it meets next week.
The February core inflation measure at 2.5 per cent was the lowest since the depths of COVID back in March 2021 and comes despite the inflationary effects of tariffs. The US trimmed-mean measures came in around 2.7 per cent, the lowest since April 2021. By contrast, the latest trimmed-mean inflation rate measure for Australia is at 3.4 per cent (12 months to January).
So on those measures, even with the price pressures arising from tariffs, the US has performed better on inflation than Australia.
It is true that measures of the inflation “pulse” (3-month annualized measures) are less benign, with core and trimmed-mean measures running at 3.0 per cent and 2.9 per cent, respectively.
Also complicating the picture a little is that the Fed’s favoured core private consumption expenditures (PCE) measure is “sticky” at 3.0 per cent (12 months to December 2025), unchanged from where it was a year ago and still well north of the Fed’s target 2 per cent. The January figure is released on Friday. Consensus expectations imply little improvement and perhaps even a slight deterioration.
Federal Reserve Chair designate, Kevin Warsh, conjectures that disinflation in the US (of which there are glimpses in CPI-based measures) will follow from tremendous (largely AI-motivated) investment. In Warsh’s view, that investment has wrought a productivity dividend that (other things equal) has raised the US economy’s “speed limit”. In other words, the US economy can grow at a faster rate before igniting inflationary pressures.
That is a credible – if eminently debatable – position.
That is what leaves the door ever so slightly ajar for policy interest rate reductions in the US.
Another question is oil prices. Do they have the potential to unanchor inflation expectations, which were already under assault from tariff impositions? Are they inflationary? Or could they ultimately be disinflationary, given the activity diminishing effects of higher oil prices.
During the 1990s and into the early 2000s, oil prices had a stronger ultimate disinflationary impact because there were a number of structural forces suppressing inflation.
It may be less true in 2026.
The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures; domestic regulation of goods and labour markets is increasing in scope leading to loss of flexibility in markets and attendant upward price pressures or “sticky” inflation”; and baby boomer workforce participation is declining (limiting labour supply and lifting wages).
But what the US has going for it is that the surge in productivity is a structural disinflationary force that is not visible elsewhere, including in Australia. US productivity growth has averaged 1.6 per cent per annum since the end of 2021. The equivalent Australian figure is -1 per cent. To put it more starkly, US productivity has grown by 6.4 per cent in that time; Australia’s productivity has fallen by 4 per cent.
That arguably puts the Fed in a better position than the RBA to “look through” any inflation impact from oil prices.
For what it is worth, in the unlikely event of a sharp decline in annual core PCE in January, I suspect that the Fed will eschew a policy rate reduction next week. The Warsh “productivity dividend” thesis is probably not yet sufficiently established to offset the current “stickiness” in core PCE inflation and there is the lingering potential for the surge in oil prices to un-anchor inflation expectations.
But if the incoming Fed Chair’s thesis is borne out, the policy rate may yet be lowered later in the year.
Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.
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