Program: Will the Iran war drive interest rates even higher?

Sam Hawley: The RBA has lifted interest rates for a second consecutive month. So has a rate hiking cycle, accelerated by the Iran war, begun. Today, Chief Business Correspondent Ian Verrender on why there could be more pain to come. I'm Sam Hawley on Gadigal land in Sydney. This is ABC News Daily.Ian, rates are up by 25 basis points to 4.1%. So the RBA is just continuing to reverse cuts it made last year, is it?

Ian Verrender: That's right. We had three cuts last year and we've had two rises this year. So it's all being unwound at a rate of knots, really, isn't it?

Sam Hawley: Sure is. Now, this, interestingly, was a close decision, though, right? Not everyone on the board thought they should go up.

Ian Verrender: Well, that's absolutely right. And that's a really important point to make. So there's nine members of the board and there are two reserve bank people on the board. That's Michelle Bullock and Andrew Howser, the governor and deputy governor. So you could say that the majority of the independents actually seem to vote the other way, because it's pretty clear that the reserve bank deputy governor, at least, thought inflation could become toxic and so was really pushing for the argument for a rate hike just over a week ago. And you would imagine that he's in lockstep with his governor, Michelle Bullock. So the two of them would have voted and they make up two of the five people who voted in favour. And of course, another four voted against this.

Sam Hawley: Well, the governor was, Ian asked about this. And well, she doesn't like people speculating about her vote.

Michele Bullock, RBA Govenor: You characterize the deputy governor and I of actually agitating for a hike in our comments. I would actually push back against that entirely. All I said.

Sam Hawley: Well, tell me then, Ian, what does the RBA board and the governor, Michelle Bullock, have to say about this decision? How do they justify it?

Ian Verrender: Look, I think if you read through the statement, the word uncertainty pops up a hell of a lot and they are to a certain extent flying blind. But they've taken the view, I would imagine, that with their bitter experience from four years ago after Russia invaded Ukraine, where they were essentially caught short, left behind and acted too late in raising rates in the face of that energy price spike then that they do not want to be caught again this time. And look, they say that with the Middle East conflict, you know, they essentially say that inflation could rise under a wide range of scenarios. So they've obviously, you know, well, wargamed, I guess, is one way to put it. Whatever comes out of this. And they've essentially come up with the idea that no matter which way this goes, it's going to create inflation, inflationary pressures on the economy, not just here, but around the world.

Sam Hawley: So they're sort of reading the tea leaves, in a sense, aren't they? They're acting before the inflation rises, but expecting because of the war, it most certainly will.

Ian Verrender: Yeah. They also point to the fact that we've got a very strong employment market at the moment and possibly stronger than they would have anticipated. So, you know, they would never come out and say it. But there's, I guess, a level of unemployment, which a lot of economists think is non-inflationary. So essentially, central banks these days try to engineer a level of unemployment that won't cause inflation.

Sam Hawley: We mentioned that there was four members of the board that did vote to keep them on hold. So what was the argument for that?

Ian Verrender: I would imagine the argument for keeping on hold would be that we're not in full possession of the data that we need at the moment to make this rate hike call, given that we've just did one a few weeks ago. And perhaps we should wait for the inflation numbers to come out. Perhaps we should wait for a little more data. And maybe we ought to wait to see how this Middle East situation resolves itself, if it does resolve.

Michele Bullock, RBA Govenor: The discussion was very much centred around the timing of a rate increase. All members agreed that another rate increase was needed to address domestic inflationary pressures. Ultimately, with inflation that is already too high, the balance of risk tilted to the upside in inflation. The board decided raising the cash rate was the right call.

Ian Verrender: So, you know, and look, that's reflected in the notes from the meeting today. And essentially, in the fact that the word uncertainty just seems to appear right through there. It's peppered right through the statement.

Sam Hawley: Yeah. And just explain, I know you've done this before, but just explain again how, you know, this shock you talk about, which of course is the war and the rising fuel costs, how that all then contributes to inflation.

Ian Verrender: Well, I mean, fuel is involved in pretty much every activity that we undertake. Everything we produce involves using fuel, even services. Energy itself requires energy to produce. So if the cost of energy rises and it's an input cost into pretty much everything we do, then it adds to the cost of all the goods and services that we consume and produce.

Sam Hawley: Well, Ian, as you mentioned, the Reserve Bank, it does make decisions, of course, by referring back in history, most recently to the war in Ukraine. But really, you have to go back a fair way before then, don't you, for a comparable period, like 50 years ago.

Ian Verrender: Yeah, absolutely. That's when we had the last really big inflationary outbreak and once again, caused by spiking fuel prices, oil prices. And again, out of the very same area that we're talking about where the conflict is now. There was a revolution that, you know, put, I guess, the whole Middle East, created a lot of instability there and it's flowing through till today. And now we've got this all-out war, which has never, we've never, despite all the confrontations and all the conflicts we've seen throughout the Middle East, we've never seen the Strait of Hormuz actually closed. We've never had every single tanker just locked into that little narrow body of water in the Persian Gulf. And which, you know, they take oil out, they take, you know, 20% of the world's gas out of there. There's a whole lot of fertilizer, there's plastics, there's all sorts of things that are trapped in that little area at the moment. So, the potential for it to have a really major impact on global growth and on the global economy is very high.

Sam Hawley: So, in 1979, when the Iranian revolution occurred, we did see sky-high inflation, you know, social upheaval, but you're saying this could potentially be worse?

Ian Verrender: Well, at that stage, we didn't have the complete closure of the straits. And that was the second big shock. The first oil shock was in 1973. That was when OPEC was formed and the OPEC nations decided that they weren't reaping the just rewards for their natural resources. So, they joined forces into a cartel, essentially, and forced up the price. So, that created havoc right throughout the world. It hit here as well. We had the Whitlam government in power at the time. And a lot of people, you know, claim the Whitlam government were terrible economic managers and maybe they weren't the greatest of economic managers, but like everyone else in the world, they had to contend with this oil price shock, which, you know, saw inflation just go absolutely sky-high and really destabilized every developed economy. And then we had, of course, as you just mentioned, we had the second one in 1979 with the Iranian revolution. But neither of those events actually stopped all oil exports from coming out of the Middle East.

Sam Hawley: Well, of course, Donald Trump's plea to nations to help him to reopen the Strait of Hormuz have really fallen on deaf ears. So, that hasn't worked in his favor at this point. It's very unclear what he's going to do about that. Now, the other thing about these rate rises, though, is that, I mean, you can keep raising rates, right, but that doesn't fix the problem of fuel prices, does it? It doesn't bring down the cost of petrol or diesel at the bowser.

Ian Verrender: Well, it won't do anything to increase the supply of oil coming out of the Middle East. It won't do anything to ensure that the refineries in Singapore and right throughout Northern Asia can deliver, you know, adequate supplies to here. It will do nothing to do that at all. The impact it will do instead of rate hikes, you know, crimping demand because it's out of control. The problem here is we've got a shortfall in supply and we've now got to bring the demand down to meet that supply, that shortfall in supply. So, you've got to really kill off demand to get it down, to grind the economy down into a situation where there isn't what's known as spare capacity, where supply and demand are in some kind of equilibrium. And that is going to involve job losses. So, we're going to see a much higher unemployment rate than we've seen in the last couple of years and a slowing in economic growth.

Sam Hawley: Well, Ian, from what you're saying, everything that you've said, the RBA is looking for an economic downturn and with that's going to come job losses. It's going to be very painful for many people. But it is something that economists like Paul Bloxham, who's at HSBC, thinks is needed to finally kill off high inflation.

Paul Bloxham, HSBC Australia chief economist: There's an increasing risk that we have to have a recession in order to get inflation down. I'm not nominating that we're going to have one at this point in time. I think, you know, a downturn is necessary and the question is going to be, you know, how big does that downturn need to be?

Sam Hawley: And there's plenty of economists, aren't there, that think really after COVID, the RBA did not hike rates high enough. What do you think about that?

Ian Verrender: Yeah, look, that's an argument set there by quite a number of economists. I disagree with it completely for the simple reason that we had interest rates where they were. They were about 0.25 per cent above where we've got them as of today. So, we're almost back up to there. And that level of interest rate managed to get inflation down from just on 8 per cent down to below 3 per cent. That interest rate worked. It got inflation right down. If you'd killed inflation or, you know, basically wounded it so much that it dropped from 8 per cent down to below 3 per cent, surely you'd be considered to be a little irresponsible by not easing back a little bit. I mean, because the danger then is if it's working and it's working really quickly, if you leave interest rates too high for too long, then suddenly it slips under 2 per cent, you end up in a recession and a lot of unemployment when it was absolutely not needed. The other argument that a lot of economists put forth is that Australia did not raise rates to the same extent as a lot of other countries. And that's absolutely true because the Reserve Bank of Australia, unlike a lot of other central banks, has two mandates. It has to maintain full employment and it has to maintain inflation at a level that is between 2 and 3 per cent. A lot of other central banks have an inflation mandate only. They don't have to consider unemployment. And if you want a case study in how not to use interest rates, that one tool, that one weapon that you've got, all you've got to do is look across the Tasman. Have a look at New Zealand. They went into recession multiple times during the last few years, at least two and possibly only missed a third one by a whisker. So the New Zealand economy was a basket case. So, you know, you can you can complain that we didn't have interest rates as high as other countries, but we're not other countries. We are our own independent country with our own independent central bank. Our economy is very different to that of America. You know, we're a resource exporting country and rural commodity exporting country. We are not a high tech country. We don't do a lot of the things that America does. We don't have much of a manufacturing base. So to try and say, well, America did this, so we should have done exactly the same. I mean, well, why don't we just give up and say, well, let America run our monetary policy?

Sam Hawley: Right. OK. That's a novel idea. All right. Well, Ian, look, is it a certainty then that we will see another rate rise, as you say, either in May or perhaps a few months later? Or if this war ends, Donald Trump says he's won it, it's finished. Could that be the end of it?

Ian Verrender: I think the impact of this is going to it's going to last quite a long time. It's not just about we've missed out on a month's worth of oil shipments. Those supply chains become stretched and choked in various parts, as we saw in the aftermath of the pandemic. It takes a long time for the problems in supply chains to work their way through. Will the bank raise rates again? Well, it depends on what happens with the numbers. Given that the board was very much split today, I don't think it's going to be an easy task to get them across the line for a third rate hike, especially any time in the near future. I mean, we've just had two hikes in two months. And, you know, the statement that they've issued today says we haven't even seen the full effects of the rate cuts from last year. So it would be to add three in a short space of time. Big call. But I guess it depends on what happens with inflation.

Sam Hawley: Ian Verrender is the ABCs chief business correspondent. This episode was produced by Sydney Pead and Cinnamon Nippard.Audio production by Sam Dunn.Our supervising producer is David Coady. I’m Sam Hawley.