The escalating conflict in the Middle East is increasing inflationary pressure! The prospect of the Australian Reserve Bank raising interest rates is heating up or completely reversing the loose monetary policy cycle of 2025.

With the Middle East conflict escalating, Australia's resurging inflation pressures, economists and traders currently expect the Reserve Bank of Australia (RBA) to raise interest rates at least twice more this year, completely reversing last year's brief and mild easing cycle. Economists from Australia's four major banks predict that the RBA will raise interest rates by 25 basis points at next Tuesday's policy meeting, and raise rates again in May, bringing the benchmark rate to 4.35%. Market expectations are even more aggressive, betting that the RBA may raise rates for a third time, increasing the benchmark rate to 4.6%, the highest level since October 2011. Hedge funds are also increasing their bullish bets on the Australian dollar, which is the best performing currency among the 10 major currencies this year. Traders expect Australia's benchmark interest rate to rise to the highest level since 2011 by the end of this year. Adam Boyton and Adelaide Timbrell, economists at ANZ Bank, stated in a research report on Thursday: "The most obvious and direct impact of the Middle East conflict on Australia is higher inflation." "When the cash rate rises to 4.35%, the RBA may consider the policy as restrictive, especially in the case of higher inflation eroding disposable income." It is worth noting that against the backdrop of ongoing and no signs of easing in the Middle East conflict, the RBA's policy meeting on March 16-17 will be the first of eight major central bank policy meetings next week. The Federal Reserve will announce its interest rate decision next Wednesday, and the Bank of Japan will announce its interest rate decision next Thursday. However, economists at ANZ Bank still believe that the RBA's interest rate decision next week will not be as certain as in February when the RBA became the first major central bank in developed economies to tighten monetary policy this year. Previously, the market generally expected the RBA to raise interest rates for the second time this year, but most forecasts were focused on May, as quarterly inflation data would be released then - this is the most important price indicator for the RBA and fits its cautious "data-dependent" strategy, while also releasing new forecasts. This week, economists have brought forward their forecast for the RBA's next interest rate hike to March, as RBA deputy governor Andrew Hauser said in an interview on Tuesday that further inflation pressures resulting from the escalation of the Middle East conflict were "not helpful." He said, "If we see further price increases due to the conflict in the Middle East - of course, there is still great uncertainty about this, that is not a favorable development for our policy discussions." The RBA's February forecasts suggest that the central bank will raise interest rates at least once again over the next few months, with overall and core inflation expected to exceed the upper limit of its 2% - 3% target range this year. Andrew Hauser stated on Tuesday: "Inflation will be higher than our forecast issued in February." "Taking necessary measures to pull inflation back from the current excessive level to the target range is crucial. I believe people should not doubt our determination to achieve this goal." Goldman Sachs' economists described Andrew Hauser's comments as "hawkish," and stated that the probability of a 25 basis point rate hike at the RBA's March meeting is "very close to fifty-fifty." Intensifying Inflation Pressure The Middle East conflict, which has caused the interruption of shipping in the Strait of Hormuz and forced multiple oil-producing countries to cut production, has already led to sharp fluctuations in the energy market - Brent crude oil reached nearly $120 per barrel on Monday, fell to around $81 per barrel on Tuesday, and rose back above $100 per barrel on Thursday. Economists Bhargavi Sakthivel and Ziad Daoud estimate that a one-month closure of the Strait of Hormuz would push Brent crude oil to $105 per barrel, while a three-month closure could push peak Brent crude oil prices to close to $164 per barrel. The rise in oil prices has already led to higher gasoline prices in Australia. A road freight company in New South Wales warned that food, groceries, fruits, and vegetables prices in supermarkets will rise next month due to higher fuel costs. Qantas Airways announced this week that it will increase international flight prices due to rising fuel prices and increased demand for long-haul flights to Europe. Prashant Newnaha, macro strategist at TD Securities, said: "Even if the US withdraws from the conflict with Iran, the damage has already been done, and the conflict is unlikely to end, which would make Brent crude oil prices fall below $70-75 per barrel." "Even though there may be a ceasefire, it will take several months for the supply chain to be repaired. There is a real risk of reduced commodity supply, which could lead to shortages and ultimately be reflected in future inflation." Amid all this, inflation pressures in Australia have started to rise again, which was the reason for the RBA's rate hike in February. A consumer inflation expectation index compiled by a private institution in Australia rose slightly to 5.2% in March (compared to 5% in February), the highest level since July 2023. The index was only 3.6% in the same period last year. This data indicates that even before the US attack on Iran at the end of February, Australia was already facing stronger inflation pressures. The RBA warned in February when it raised rates that inflation was showing stubbornness as demand continued to outstrip economic capacity. The RBA's February forecasts suggest that the inflation rate will peak at 4.2% this year and then gradually decline, returning to near the midpoint of the 2% - 3% target range by 2028. These estimates are based on a technical assumption that oil prices will remain at $63.8 per barrel until mid-2028, and that the cash rate will be 4.2% in December this year, rising to 4.3% by the end of 2027. Some economists now predict that Australia's inflation rate will peak at or above 5% this year. Belinda Allen, head of Australian economics at the Commonwealth Bank of Australia, said: "High-frequency consumer inflation expectations are rising. Given that the economy is already running above capacity and inflation is too high, this will be a concern for the RBA's Monetary Policy Committee. The debate will be fierce, as it should be, and ultimately we expect the RBA to focus on inflation and raise rates in March and May."