Reserve Bank governor warns of the recession we might have to have after interest rate hike

There's a saying that generals always prepare for the last war, and so it may be for central bankers.

Seemingly burnt by their dismissal of the post-COVID, post-Ukraine war inflation breakout as "transitory", central bankers are already reacting to the spike in prices caused by supply disruptions triggered by the Iran war.

Australia's Reserve Bank is the first of eight major advanced economy central banks meeting this week, and it wasted no time hiking its cash rate for the second month in a row to 4.1 per cent.

While it's the only one expected to hike rates this week, previous hopes of rate cuts have been priced out for some of the others.

It's not surprising that we're leading the way globally on rate hikes, given that inflation here is now substantially higher than in all those other countries.

Asked by the ABC's David Chau whether the Reserve Bank would be prepared to drive Australia into recession to control inflation, RBA governor Michele Bullock was unequivocal.

"We don't want to have a recession, but if it's hard to get inflation down, then we're going to have to deal with that, possibly," she responded.

The governor repeated previous arguments that inflation is the biggest threat to the economy, generally hits poorer people harder, and is ultimately incompatible with economic growth over the longer term.

"If we don't have low and stable inflation over time, we won't have full employment," she asserted.

Last year's economic boom triggers this year's rate rises

This paragraph from the RBA's post-meeting statement summed up the rationale behind today's hike.

"While inflation has fallen substantially since its peak in 2022, it picked up materially in the second half of 2025. Information since the February meeting suggests that some of the increase in inflation reflects greater capacity pressures," the RBA noted.

"In addition, the conflict in the Middle East has resulted in sharply higher fuel prices, which, if sustained, will add to inflation.

"Short-term measures of inflation expectations have already risen. As a result, the Board judged that there is a material risk that inflation will remain above target for longer than previously anticipated.

"Higher capacity pressures reflect, in part, the greater momentum in demand in the latter part of 2025. Growth in private demand strengthened substantially more than was expected in mid-2025."

Reading over that a few times, it becomes apparent that last year's strong economy has inspired this year's rate rises, with the inflationary shock of the Iran war perhaps bringing forward the timing of the second hike from May to now.

Australians most pessimistic since COVID lockdowns

But more timely economic data casts a shadow over this picture.

Consumer confidence data out this week, taken after the start of the Iran war and attendant surge in fuel prices, shows deep pessimism.

"At 68.5pts, the ANZ-Roy Morgan Australian Consumer Confidence is now at its lowest since March 2020, when the first pandemic lockdowns were announced," ANZ economist Sophia Angala noted.

"Households are increasingly pessimistic about the one-year and five-year outlooks for the economy, likely driven by geopolitical uncertainty and the shifting outlook for inflation and rates."

Fewer than one in six Australian households feel better off financially than a year ago, while more than half feel worse off — despite the fact that the cash rate is now back to exactly where it was this time last year.

Asked about this, Ms Bullock batted it off.

"It all depends on how confidence flows through into what people actually do in terms of spending," she responded.

"Confidence has been low for some time, but the consumers have been continuing to spend."

Rate expectations already spooked consumers before Iran war

Although the most recent data casts doubt on this.

Even before Israel and the US attacked Iran, which responded by effectively blocking the world's key energy artery, consumers appeared to be cutting back, spooked by the RBA's February rate hike.

CBA's monthly spending indicator fell for the first time in almost one and a half years last month, continuing a trend evident in slightly older ABS data showing household spending growth slowing.

This isn't surprising, given that household saving rates had been on the way up, even before February's interest rate rise was actually delivered.

"The leading edge of the data shows changing policy expectations taking the heat out of consumption," wrote JP Morgan economist Ben Jarman.

"It is worth noting that around half of this impact did not require the cash rate to go up at all — just for expectations of cuts to be taken out."

That prompted my question to the RBA boss:

"The most recent private sector measures show household spending now falling and consumer confidence plunging to pandemic levels. Is there a risk you're fighting last year's battles and might crunch an already weakening economy with this rate hike?"

"Well, it's possible, I suppose. It's not our central forecast," Ms Bullock replied.

Going back to David Chau's earlier question, it's clear that crunching the economy is a risk the RBA's staff, if not all of its board members, feel is worth taking to tame inflation.

Even if it doesn't lead to a recession — whether measured by two consecutive quarters of economic contraction or by a steep jump in unemployment — the RBA governor was clear Australians should brace for more economic weakness ahead.

"Demand can't grow very quickly if supply isn't growing very quickly," she argued.

"So the days of 2.5, 3 per cent growth rates of demand are very difficult where you've got a supply constrained economy."

With households hit by the triple whammy of surging fuel prices, rising flow-on costs across the economy and increasing mortgage costs, all amid modest wage growth, it seems increasingly unlikely excess demand will be a problem for much longer.