The Reserve Bank’s Monetary Policy Board will meet this morning with the price of Brent crude oil above $US100 a barrel and the entrance to the Persian Gulf closed for the first time in history.
Will they cut interest rates tomorrow to ease the pain of higher energy prices and prevent a rise in unemployment? Or raise rates to stop inflation from going higher and bring it down?
Answer: the latter, of course.
Iran war live updates: For the latest news on the Middle East crisis, read our blog.
The RBA, along with all central banks, sees its main job as controlling prices by manipulating demand through interest rates and inflation expectations via public statements.
As for its other mandate — “the maintenance of full employment” — the RBA’s definition of that is whatever it needs to be to achieve the other thing.
So economists, almost as one, are predicting another rate hike tomorrow, and the futures market puts the odds of it at 72 per cent — not a betting certainty, but let’s face it, it’s going to happen.
Read more about the Iran war:There is no precedent
The problem for the nine decision makers on the Monetary Policy Board is that there is neither a precedent for what’s happening in the Middle East nor a clear idea of exactly what is happening.
Consequences of Iran war go beyond petrol pump
On Thursday last week, the International Energy Agency (IEA) published a new report starting with this sentence: “The war in the Middle East is creating the largest supply disruption in the history of the global oil market.”
The IEA was created in 1974, so it’s pretty familiar with the two oil shocks of the 1970s and obviously thinks this is worse than 1973 and 1979, when the price of oil quadrupled and then doubled.
But as economist Paul Krugman argued the other day, “oil experts’ hair is on fire — the Strait of Hormuz is closed! — while macro-economists are relatively calm, arguing that we’re not as vulnerable to an oil shock as we were two generations ago”.
The oil price is “only” up about 50 per cent so far, but the Strait of Hormuz has never been completely closed before, and that affects a lot more than oil — a large proportion of the world’s LNG, urea, chemical feed stocks and sulphur are also locked in.
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The key issue for the global economy, therefore, is how long the strait will be closed, and nobody has any idea about that.Â
On Friday, the new supreme leader of Iran and son of the previous one, Mojtaba Khamenei, issued a statement that was read on national TV by a newsreader (not by him), saying the Strait of Hormuz would remain closed until the war ended.
At around the same time, US President Donald Trump told a reporter on the phone that there is “practically nothing left to target” and “any time I want it to end, it will end”.
And then Iran’s Islamic Revolutionary Guard Corps responded that they “are the ones who will determine the end of the war”, and that Tehran would not allow the export of “a single litre of oil” from the Gulf as long as the US and Israeli attacks continued.
So the war will only stop and the strait reopen if either the US and Israel manage to kill the entire Iranian leadership, which seems unlikely since we’re talking an inner circle of about 30 and parliament and clerics numbering about 2,000 scattered all over the place and in bunkers, or else Trump declares victory and walks away, which is more likely since he has already done it a few times.
There’s also a question of how long Iran itself can last with the strait closed, since almost all of its oil comes from Kharg Island inside the Gulf, and not much of that is getting out now.
There have been some reports of Chinese tankers loaded with Kharg Island oil being allowed through the Strait of Hormuz, so it seems the Gulf would only be completely closed if the US starts blowing up Chinese ships, which would be a big step, to say the least.
In 2021, Iran completed a 1,100-kilometre pipeline from Goreh at the top of Persian Gulf to the port of Jask on the other side of Hormuz, explicitly to allow it to close the strait and still ship oil.
The pipeline’s theoretical capacity is 1 million barrels a day — about half of Iran’s exports in 2025 — but the terminal in Jask is apparently not up to that yet by a long way.
Only five tankers have been successfully loaded there so far and the IEA describes it as “effectively non-operational”.
LoadingHow long will the war continue?
So it gets back to how long the US and Israel will keep bombing Iran and whether they decide to go all in with “boots on the ground” and invade the country, as the US did in Iraq and Afghanistan.
Military analysts say that it is very unlikely because Iran is larger and more complicated than either Iraq or Afghanistan, so it would be even more of a quagmire than they were.
Running on empty — how we were caught short of oil
Regime change was never going to happen without an invasion, and the regime is now focused on survival.
In any case, the US may be losing control. Israel is making it clear in Lebanon that it is taking this opportunity to eliminate its enemies, so it might not stop when the US does, and Iran seems to be trying to do something similar with its Arab enemies on the other side of the Persian Gulf.
The war might also spread, forcing the Arab Gulf states and Türkiye to join the war, especially if it looks like Iranian Kurds are being armed ahead of an opportunistic uprising. They would all have different objectives from the US or Israel, massively complicating any negotiations for an end to the war.
Moreover, damage to energy infrastructure could mean the economic impact lasts much longer than the war itself.
Economic consulting firm, Capital Economics, estimates that if the conflict goes for three months, including damage to Kharg Island, as much as 8-9 per cent of world oil and LNG exports would be lost into 2027.
The oil price would go to $US150 a barrel, it says, and global gas prices would also rise steeply.
LoadingThe impact on Australia
In Australia, a long-lasting rise in fuel prices would worsen the affordability crisis caused by post-pandemic inflation and house prices, which would be made much worse if the Reserve Bank responded by crushing borrowers with a series of rate hikes.
Everyday items that may be affected by fuel prices
Most economists think there’ll be at least two more — one tomorrow and another in May — while the futures market has the cash rate at 4.55 per cent in November, so there are 80 per cent odds of a third hike as well.
The reason the RBA would do this, and not “look through” the increase in energy prices as it did last June when the oil price jumped 20 per cent as a result of the 12-day war with Iran, is to ensure inflation does not get embedded in expectations, and therefore in wage agreements and other CPI-linked costs.
Tough talk, as both the governor and deputy governor have been doing lately, only goes so far.
At some point, so the thinking goes, there’s a recession you have to have.
Alan Kohler is finance presenter and columnist on ABC News and he also writes for Intelligent Investor.
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