The RBA Can't Fix Oil Prices. So Why Is It Acting?

Petrol is expensive, the conflict in the Middle East is the obvious reason, and the Reserve Bank has just raised interest rates again. Put those three facts together and a lot of people reach the same conclusion: the RBA is punishing mortgage holders for something that is happening on the other side of the world.

The Governor addressed that head-on after the 3 November decision. "I know there is confusion in the community, so I want to be very clear," Michele Bullock said. "Monetary policy cannot impact global oil prices."

So if rates can't fix oil, why move them at all? The answer lies in the difference between the first hit of a price shock and the ripples that follow.

Round one: the direct hit

When the global price of crude oil jumps, the first thing you notice is the price on the bowser. That is the first-round effect, and an Australian interest rate rise does nothing to it. Oil is priced in global markets. Whether the cash rate is 4.60% or 4.85% makes no difference to what a barrel costs.

The RBA's own assumption shows how big this shock is. The oil price it assumes for the December quarter is 35% higher than the one it used in August, after the conflict escalated again. That flows quickly into headline inflation, which the RBA expects to peak at around 4.5% this quarter.

If that were the whole story, most central banks would "look through" it. A one-off jump in fuel prices raises the price level, but it doesn't keep inflation high year after year, and squeezing the economy to offset it would just add pain on top of pain.

Round two: the ripples

The trouble is that fuel isn't only something you buy. It goes into almost everything else. Trucks carry groceries. Planes need jet fuel. Farms run diesel machinery. Plastics and fertilisers come from petroleum. When fuel costs rise, those businesses face higher costs too, and many of them try to pass the costs on.

These are second-round effects, and this is where monetary policy can make a difference. As the Governor put it, "While monetary policy can't do anything about the direct effects of an oil price rise, it can help to limit the indirect effects of the rise." The board's statement says there are already "indications that higher fuel prices are being passed through to prices of other goods and services."

How far those ripples spread depends on demand. If customers are spending freely, a café or a freight company can lift its prices and keep its sales. If customers are cautious, it is harder to pass costs on, and more of the shock is absorbed in margins. Higher interest rates cool demand, which makes it harder for the fuel shock to spread from the bowser into the price of everything else.

Why the timing matters

There is a second reason the RBA is acting now: the economy was already running hot before the oil shock arrived. The board started raising rates in February, before the conflict began, because of domestic capacity pressures. It now thinks those pressures were bigger than it realised.

When a supply shock hits an economy that is already stretched, the risk of second-round effects is much higher. Businesses that already had pricing power have even more reason to use it. Workers who have watched prices rise for years push harder for pay rises. And the longer inflation stays high, the more likely people are to expect it to stay high.

What rates can and can't do

It helps to be precise about this.

Rates can't lower the price of petrol, end a conflict or reopen a shipping route. Rates can slow overall spending, which makes it harder for businesses to pass rising costs on, and they can show that the RBA won't let a temporary shock become permanent inflation.

That second job is mostly about expectations. If everyone believes the RBA will bring inflation back to 2–3%, a fuel shock stays a fuel shock. If people start to doubt it, the shock can turn into a wage-price spiral that lasts far longer than the conflict.

None of this makes the trade-off painless. Households with mortgages pay a real price for a problem they didn't cause. But the RBA's argument is that the alternative is worse: inflation that outlives the oil shock and needs even higher rates to stamp out later.