Focus · Capitals Wire
A s universally expected by economists and financial markets, the Reserve Bank’s monetary policy board on Tuesday lifted its cash rate by 25 basis points to 4.6%, the highest level since October 2011 (at the peak of the mining investment boom). Treasurer Jim Chalmers has attributed this week’s decision – and the inflation concerns underpinning it – to the war in the Middle East. Others, including shadow treasurer Tim Wilson and some economists , blame it on “excessive” levels of, and growth in, government spending.
In truth both of these factors, and others besides, have contributed to the rebound in inflation and interest rates that Australia has experienced this year. Sign up for the Breaking News Australia email Oil prices have rebounded from just over US$70 a barrel in late June, when it briefly appeared that the Middle East conflict might be over, to more than US$100 a barrel in recent weeks, now that there seems little prospect of an imminent end to that conflict. Less well recognised, but no less important, the “crack spreads” between crude oil prices and prices of refined petroleum products such as gasoline and diesel, have remained at elevated levels since the conflict began, and seem unlikely to come down given the damage that has been done to refining capacity in the Middle East and in Russia.
Additionally, the US (the world’s biggest oil producer) and China (the world’s biggest oil importer) appear to have run down their reserves as far as they deem prudent, and so are now exporting less and importing more oil, respectively, than they had been doing in the early months of the conflict. These influences have been evident in other “advanced” economies which have lifted their interest rates in recent weeks in response to higher inflation – including the US, Japan, South Korea, the Euro area and New Zealand. But the rebound in Australian inflation began well before Donald Trump and Benjamin Netanyahu started the conflict in the Middle East.
The RBA’s preferred measure of “underlying” inflation bottomed out at 2.8% over the year to June 2025, and had already risen to 3.3% by February this year, before the outbreak of the conflict. Since then, this measure of underlying inflation has risen to 3.6% over the year to July. So most of the increase in inflation which prompted the Reserve Bank to raise interest rates three times between February and May this year can’t be attributed to the conflict in the Middle East.
Rather, it reflects the persistent imbalance between “aggregate demand” – the sum total of spending on goods and services by Australian households, businesses and governments – and “aggregate supply” – the sum total of what is produced by businesses and governments, less what is exported to foreign countries, plus what is imported from abroad. The growth of aggregate supply has been held down by our abysmal productivity performance during this decade, which effectively sets a “speed limit” on how fast our economy can grow, once we’ve attained “full employment” (which we have done since 2022), without generating inflationary pressure. Growth in aggregate demand has been driven by both public and private spending.
Growth in public spending as measured in the GDP statistics has slowed – from more than 4% per annum in real terms in 2023-24 and 2024-25 to 2% in 2025-26. But the national accounts measures of public spending only include direct spending by governments and government-owned enterprises on goods and services. They don’t includes other forms of government spending – in particular, cash payments to households and cost-of-living relief measures which the federal government and, of no less importance, state and territory governments have handed out in recent years. skip past newsletter promotion after newsletter promotion Thus the final budget outcome document released on Monday showed that total expenses by the federal government rose by 5.1% in real terms in 2025-26, only marginally less than the 5.6% figure for 2024-25, and that both of those figures were higher than in all but five of the past 25 years.
And although most of the states and territories are yet to publish their equivalent documents, based on the estimates presented in their 2026-27 budgets it is likely that spending by state and territory governments and their instrumentalities rose by about 6% in real terms in 2025-26 – the largest increase since 2019-20. Most of the cost-of-living relief given by the federal, and state and territory, governments, whether by way of cash handouts or tax cuts (such as the temporary halving of fuel excise) has been untargeted – that is, it has been given to households who might not need it as well as those who undoubtedly do. And most households appear to have spent it.
That shows up in the national accounts as private sector spending – but it has really been facilitated by government policy. In circumstances where inflation is running persistently above the Reserve Bank’s target because aggregate demand is running persistently in excess of aggregate supply, what governments give by way of cost-of-living relief or tax cuts, the Reserve Bank takes away in the form of higher interest rates. Except that the burden of higher interest rates falls primarily on a smaller group of households – those with big mortgages – than those who received the cost-of-living relief and tax cuts.
The Reserve Bank itself has to accept some of the blame for the rebound in inflation, and hence in interest rates. That’s because – with the benefit of hindsight – they cut interest rates prematurely last year. Their belief that inflation had sustainably returned to their 2% to 3% target band turned out to be wrong.
They were of course under considerable pressure from the government to cut rates – recall, for example, Chalmers’ unjustified assertion in August 2024 that the Reserve Bank had “smashed the economy” (if it had, inflation wouldn’t have rebounded in the way that it subsequently did). But – again, with the benefit of hindsight – they should have resisted that pressure. In many ways this “blame game” is beside the point.
As RBA governor Michele Bullock re-iterated this week, “high inflation hurts all Australians, especially the most vulnerable” and “it’s critical that we stop high inflation from becoming embedded in price setting decisions across the economy or the problem will only get worse”. Politicians should avoid doing, or advocating, things that will “make the problem worse”, and let the Reserve Bank get on with its job.
Source: The Guardian
