Australia's inflation forecasts are sending a clear message: the Reserve Bank of Australia (RBA) may need to raise interest rates sooner than expected. The Iran war has sparked a significant energy shock, and two of the country's largest banks, Commonwealth Bank of Australia (CBA) and Westpac, are predicting a sharp rise in consumer prices for the March quarter. This could put the RBA in a tricky position, as it may need to act to control inflation while also considering the impact on economic growth.
The Inflation Forecast
Both banks are forecasting a strong increase in headline inflation for the March quarter, with CBA predicting a 1.1% rise and an annual rate of 4.6%. Westpac's numbers are slightly lower, but still point to a significant increase, with a quarterly gain of 1.5% and an annual rate of 4.2%. The trimmed mean inflation, a measure that filters out volatile prices, is also expected to rise, with both banks forecasting a quarterly gain of around 0.9%.
The Energy Shock
The primary driver of this inflationary pressure is the energy shock caused by the Iran war. Auto fuel prices have surged since the conflict began on February 28, and both banks attribute the bulk of the energy shock to this sector. However, Westpac warns that this is just the beginning. The bank describes the Middle East conflict as the largest energy shock since the 1970s oil crises and expects the inflationary impact to broaden significantly in the June quarter and throughout the second half of 2026.
Implications for the RBA
These forecasts carry clear hawkish implications for Australian rates. If the trimmed mean inflation prints at 0.9% for the quarter and the annual rate lifts to 3.5%, as both banks expect, the RBA will face significant pressure to act at its May meeting. CBA explicitly calls for a 25 basis point hike to 4.35%, acknowledging the decision will be close. Bond markets are likely to price in a higher probability of a May move, and the Australian dollar could find support if the RBA is seen moving while other central banks remain on hold.
Long-Term Concerns
Westpac's longer-term concern is that the Iran conflict represents the largest energy shock since the 1970s oil crises, suggesting that inflation risks are skewed to the upside well into the second half of 2026. This limits the scope for any subsequent easing cycle, as the RBA may need to keep rates higher for longer to control inflation.
Conclusion
In conclusion, Australia's inflation forecasts are a stark reminder of the challenges facing the RBA. The energy shock from the Iran war is already having a significant impact, and the central bank may need to raise interest rates sooner than expected to control inflation. The longer-term implications of the conflict suggest that the RBA will need to be cautious and may need to keep rates higher for longer to avoid a prolonged period of high inflation.
