A Commentary By CreditorWatch, Chief Economist, Mr Ivan Colhoun
Key takeaways:
- Inflation was slightly softer than expected, but still well above target: Underlying inflation appears closer to ~3.25% pre‑Iran conflict, lower than recent RBA rhetoric but still materially above the 2.5% target, implying further policy tightening is ultimately required.
- Fuel prices are now the dominant inflation driver and a growing economic risk: Sharp rises in petrol and diesel added 1.1 percentage points to headline inflation, accelerating annual inflation and materially increasing cost pressures on businesses.
- The RBA faces a difficult timing decision: Markets are heavily priced for a rate hike next week, but deteriorating confidence, weaker auction clearance rates and uncertainty around the Strait of Hormuz argue for caution.
- Geopolitics could tip tightening into recession risk: A prolonged Strait of Hormuz closure would likely drive much higher energy prices, rationing and recession, suggesting a prudent case for waiting for clarity, even though tighter policy remains the base case once conditions stabilise.
Summary:
Today’s inflation data was a little better than expected, but also confirmed that even before the Iran conflict, Australian inflation continued to run materially above the RBA’s target. That suggests further monetary policy tightening will be delivered, with the only question being the timing.
The market remains substantially priced for a move next week, though I assess there to be a lesser risk than priced given the substantial impacts on confidence and auction clearance rates and the unknown duration of the Strait of Hormuz closure. That suggests a prudent course of action could be to await further clarification of the Strait of Hormuz closure, before tightening further, as an extended closure carries a significant risk of recession.
If a further tightening is enacted next Tuesday, of itself, this would likely not cause recession, but when combined with current elevated fuel prices, would create significant additional pressure on businesses. It will be important that the Strait of Hormuz reopens soon.
Analysis:
Both the monthly (+0.26% m/m) and quarterly (+0.8%) trimmed means rose by less than expected in March and Q1 2026, respectively. These tend to suggest that underlying inflation was running closer to 3.25% ahead of the Iran conflict, a little lower than the RBA Deputy Governor recently characterised (3.5% y/y). Even at 3.25% however the rate of inflation is too high and will require somewhat tighter policy, in the absence of a very extended closure of the Strait of Hormuz, which threatens recession.
The 33% rise in petrol prices and the 41% increase in retail diesel prices (the latter accounts for 10% of the fuel basket) were as expected and contributed 1.1 percentage points to headline inflation. This saw the y/y rate accelerate from 3.7% to 4.6% for the monthly series, broadly as expected. The quarterly y/y rate rose only slightly from 3.4% to 3.5%, as fuel prices only rose around 5.5% in the quarter.
The table starkly reveals the challenge facing the RBA. Only two categories are recording inflation below the 2.5% target (Communications and Furniture, Household Equipment and Services, which together comprise only around 10% of the CPI). Two categories (Recreation and Culture and Insurance and Financial Services) are close to target (18% of the index), while the remaining 72% is running at 3% or higher rates (and 55% at over 4%). The maths obviously does not compute with 2.5% inflation, requiring the RBA to continue to enact tighter policy to deliver its 2.5% inflation target.
The increases reflect less favourable developments in the highly weighted housing components, though rents rose only 0.2% m/m. Electricity price rises y/y continue to reflect the previous end of subsidies, while previous rises in gold and silver prices have produced very large rises in jewellery prices.
Were it not for Middle East developments, a further tightening at next week’s May board meeting would be close to a lay down misère. RBA communications in the lead up to the meeting were hawkish, leading the market to conclude a further tightening will be the staff recommendation to the Board.
However, higher energy prices also impact demand (a taste of which we have seen in consumer and business confidence and auction clearance rates), meaning business liaison evidence the RBA is receiving but which the market does not, will be important in the decision. And of course, if the Strait of Hormuz closure turns out to be an extended affair, this would likely see much higher oil prices, rationing and the world and Australian economies end in recession. This suggests there is an argument that a prudent course of action would be to wait for further clarification of the outlook before tightening further. This was the position of four of the nine members of the Monetary Policy Board in March.
Importantly, this does not mean that further monetary policy tightening is not required. My base case is that the Strait of Hormuz situation will be resolved relatively soon, allowing the pre-Iran improving US and Australian economy scenarios to re-establish and the RBA to continue to enact tighter policy.
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Source: Creditorwatch
