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This week's March CPI data confirm that Australia's inflation problem remains unresolved, and that progress back to the RBA’s target is going to be slow. Headline inflation jumped to 4.6% in the year to March, the fastest pace since 2023, up from 3.7% in February. Underlying inflation lifted to 3.5% in the March quarter and remains stuck firmly above the upper limit of the RBA's target band. With inflation so elevated, the RBA will be forced to lift rates when it meets next week or risk losing its inflation-fighting credibility.
Of course, much of the rise in headline inflation was driven by a 33% surge in fuel prices, the largest monthly increase since the ABS began publishing monthly data in 2017. Regular unleaded petrol prices rose from $1.70/litre in February to over $2.20/litre in March, while diesel prices jumped even higher from $1.80/litre to almost $2.60/litre. This predates the temporary halving of the fuel excise tax from 1 April that has seen unleaded fuel prices drop back below $1.90/litre nationally. Despite the excise cut, diesel prices have not fallen from their March average.
The first-round fuel price increase felt by motorists in March is only the start of the energy inflation story emanating from the war in Iran. What comes next, and what the RBA can impact via monetary policy, is how much further inflation could rise via second round effects.
Oil price shocks are difficult to contain because fuel is an input into almost everything the economy produces and transports. Diesel, in particular, is used intensively in Australia's agriculture, mining, road transport, manufacturing and construction industries. When fuel prices rise, they first impact consumers directly, then gradually flow through supply chains via indirect effects and second-round impacts, over the next six months.
The pass-through process takes time and there was little evidence of supply-chain pass through in the March CPI data. However, the ABS did highlight a 3.6% rise in postal services in the month that reflected the impact of higher fuel costs on parcel delivery fees, but this contributed very little to inflation given its small weight. Companies also lifted or implemented new fuel levies in April, so further increases are likely next month. But there are other important sources of indirect and second-round inflationary impacts.
Two such sources are groceries and new home builds, which together, account for roughly one-fifth of the consumer basket.
Farmgate costs have already risen by around 10% due to the conflict in Iran. Higher diesel prices lift the cost of planting, harvesting and distributing food, while fertiliser and plastics prices have also lifted due to production disruptions in the Middle East. Supermarket prices will respond with a lag as higher farm and freight costs work their way through to wholesalers and retailers.
Construction cost inflation was already rising and the cost of building a new home is one of the largest contributors to CPI inflation. Building costs will rise even further as input costs lift by over 5% due to the conflict in Iran. Plastics, insulation, piping and sealants rely heavily on resin‑based petrochemicals, making building supply chains particularly sensitive to oil prices. Plumbing, steel, cement and ceramic product prices have also all risen. As higher input costs impact manufacturers and wholesalers, they eventually surface in higher build costs and contract prices.
Importantly, these price increases are yet to appear in the CPI. If they were to be fully passed on to consumers, inflation would certainly continue to rise. And so would the cash rate.
However, the conflict in Iran is not expected to permanently lift energy prices. We place only a 10% weight on our Malignant (permanent price shock) scenario. If the conflict is resolved toward the end of June and the Strait of Hormuz reopens, consistent with our Benign scenario, global oil supply would start to increase and oil prices would start to fall. That would send the first-round fuel price impacts on consumers into reverse. And crucially, it would blunt second-round pass through of the inflationary pressures now building upstream.
It is precisely in this environment that would see the May rate hike from the RBA to be the last. However, with oil prices continuing to rise this week and no sign of a deal between the US and Iran, there is a building risk that OUR Malign scenario (where oil prices spike above US$120/bbl) could play out, which would necessitate at least one additional rate hike from the RBA.
