RBA warns of interest rate hikes amid Russian war, Covid supply chain

At the AFR business summit on Wednesday, Reserve Bank of Australia (RBA) governor Philip Lowe warned that supply chain issues sparked by the eastern European war could trigger a wave of inflation.

This in turn could force him into bringing up the interest rate earlier than he intended.

“The war in Ukraine and the sanctions against Russia have created a new supply shock that is pushing prices up, especially for commodities,” Dr Lowe said at the business conference.

“This new supply shock will extend the period of inflation being above central banks’ targets.”

In particular, Dr Lowe is concerned that Australians’ attitudes will shift, making it inevitable to fight against inflation by increasing the interest rate.

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The official cash rate has been at a record low of 0.1 per cent since November 2020 in response to the Covid-19 pandemic but it is expected to jump by 1 per cent by the end of this year and hit 1.25 per cent next year.

Although a 1 per cent rise sounds like a tiny amount, it could add hundreds or even thousands of dollars extra every month for the average Australian mortgage.

Dr Lowe believes that a shifting mindset among Australians is “critical” to the RBA’s decision, as it could be damaging to the economy and would potentially force his hand.

People could start believing that the price rises were there to stay, making it difficult for central banks to keep inflation under control.

“This runs the risk that the low-inflation psychology that has characterised many advanced economies over the past two decades starts to shift,” he said.

“If so, the higher inflation would be more persistent and broadbased, and require a larger monetary policy response.”

Last month, the Commonwealth Bank warned that the interest rate could rise by as early as June this year – and that was before Russia began its invasion of Ukraine.

At the time, the RBA assured Australians that it would be at least another six months before they lifted rates, saying they would need to see two more quarterly inflation reports.

However, on Wednesday, Dr Lowe made no such promise.

“We don’t have a plan that’s locked in,” he told conference attendees.

That said, he also added that it was possible that the higher prices could blow over and everything could go back to relative normality.

“We can afford to look through a period of temporarily high inflation because of higher oil prices and commodity price shocks if we think that they will eventually wash through,” he said.

So far this year, oil and thermal coal prices have risen by a whopping 40 per cent, while wheat has risen by the same amount in the space of just a month.

Europe is in for a rocky ride in the coming weeks as a result of this.

“For the countries in Europe, this rise in commodity prices represents a negative shock to their terms of trade and thus to their national income,” Dr Lowe said.

“This alone will cause a slowdown in economic activity.”

However, Australia could find itself in a unique position because we export some of these commodities, meaning there could be a chance of benefiting from the increased prices.