The ‘double whammy’ of rising fuel costs and interest rates

Matt Grudnoff calls it the “double whammy”.

Since the United States and Israel attacked Iran three weeks ago, fuel suppliers have been hitting Australian consumers with huge increases in the cost of petrol and diesel. Then, on Tuesday, the Reserve Bank hit them again, with its decision to raise interest rates to 4.1 per cent.

Grudnoff, senior economist at The Australia Institute, believes there was no need for the RBA’s move on rates, given the economic pain inflicted by the fuel price rises. The way he looks at it, fuel price hikes had essentially done the central bank’s job: that job being to slow an economy running faster than its “speed limit”.

The bank, in its Tuesday statement, said it had been surprised by “greater momentum in demand in the latter part of 2025”, which had pushed inflation to 3.8 per cent, well above its 2-3 per cent target range. So it raised rates a quarter point, for the second time this year, to try to slow things down.

It’s the standard central bank response to one kind of inflation, says Grudnoff.

“Interest rates are a demand management tool,” he says. “When interest rates go up, it sucks money out of households’ pockets, they don’t have as much to spend because they’re paying more on their mortgages, and so that reduces demand and stops that kind of inflation.”

The consequence of expanding war in the Middle East is not that kind of inflation, however. The bombing of Iran – including attacks on the country’s oil and gas infrastructure – and Iran’s response in hitting oil and gas infrastructure in neighbouring Gulf states and blocking most oil shipments through the Strait of Hormuz – have driven up global energy prices.

This is not a demand problem; it is a supply problem.

“And increasing interest rates doesn’t work on the supply side,” says Grudnoff. “It doesn’t matter how high Australian interest rates go, that is not going to open the Strait of Hormuz.”

Grudnoff cites estimates that the petrol price rises this month equate to a roughly 20 basis point hike in interest rates – almost as big a hit to consumers as the RBA’s latest move.

“If you’re spending more filling your car up, then you have less to spend on everything else,” he says. “So consumers have suffered kind of a double whammy. And if it [the high oil price] persists for longer, obviously that impact is going to be larger.”

Higher fuel prices are themselves inflationary. They impact not just the cost of filling the family car but also the cost of manufacturing, freight transport and farming – which in turn flows to food prices. Even electricity prices will rise, because gas is used to generate some of that power and effectively sets the price for the whole market when electricity from other sources is in short supply. Gas is also used to make fertilisers and plastics – and global gas prices also are ballooning.

The big question is, how long will the war continue?

Some have suggested the TACO principle – Trump Always Chickens Out – means the US president will quickly declare victory in Iran and end the war, after which global energy prices will promptly return to normal.

Certainly, there are good reasons for him to want to get out of Iran quickly. The war is widely seen by Americans as an expensive folly. Witness the resignation this week of the Trump-appointed director of the National Counterterrorism Centre, Joe Kent.

“I cannot in good conscience support the ongoing war in Iran,” he wrote in his resignation letter. “Iran posed no imminent threat to our nation, and it is clear that we started this war due to pressure from Israel and its powerful American lobby.”

His words fuelled an ugly internecine war between the pro- and anti-Israel sections of the MAGA base. His assessment that Iran posed no imminent threat to the US appears to be shared by the nation’s intelligence and security agencies, as well as the majority of the public.

“Increasing interest rates doesn’t work on the supply side. It doesn’t matter how high Australian interest rates go, that is not going to open the Strait of Hormuz.”

Despite this, though, Trump has yet to offer any firm suggestion of when the US might cease hostilities. He told Fox News this week the war would end when he could “feel it in my bones” that it was time.

Regardless of what Trump does, though, Israel may well continue attacks. Polls suggest about 80 per cent of Israeli citizens support them, and the Netanyahu government, which faces an election in October, appears undeterred by the impact on global energy supplies. On Wednesday, Israel attacked the vast offshore South Pars gas field, the world’s largest, jointly operated by Iran and Qatar.

Bottom line, the crisis will be with us for a long time, says Warwick McKibbin, director of the Centre for Applied Macroeconomic Analysis (CAMA) at the Australian National University and a former Reserve Bank board member.

“There’s going to be chaos,” he tells The Saturday Paper. “There’s going to be all sorts of problems in the Strait of Hormuz. So you’ve got elevated oil prices, probably $100 or more a barrel for quite a long time. This can go on for quite a few years.”

On Thursday, the treasurer shared similar concerns publicly. Under the best-case scenario, Jim Chalmers said, the oil price would stay at US$100 a barrel for the first half of the year, gradually returning to prewar levels of about US$70 by year’s end. This would push inflation to about 4.5 per cent this year, and shave 0.2 per cent from GDP.

Alternatively, if the war was more prolonged, oil could hit US$120 by midyear and take three years to return to prewar levels. Inflation would reach more than 5 per cent this year, and economic growth would be 0.6 per cent lower.

Chalmers said his department was still working on a third “and more drastic scenario” with even graver implications for inflation and the broader economy.

Clearly, a lot of economic pain may be ahead, especially for consumers, which raises the question of why the RBA chose on Tuesday to inflict more by raising interest rates.

The answer to that question is that the central bank had its eyes on the rear-view mirror. It was responding to the recent bump in domestic inflation, not the impending threat of global recession. The statement released by the bank’s Monetary Policy Board, and RBA governor Michele Bullock, in her Tuesday media conference, repeatedly stressed it was driven by concern about “inflationary expectations”.

Translated by independent economist Saul Eslake, what that means is “that businesses, if they expect inflation to remain high, will raise prices not just to claw back cost increases that they’ve already experienced but also to try and get in front of the cost increases they think will occur in the next 12 months”.

Likewise workers and their unions. The result is a so-called wage-price spiral, such as the bank worried about during the inflation breakout in the wake of the pandemic – although, as it turned out, it was a spiral driven in large part by businesses raising prices, and by public spending, rather than workers.

The bank was intent on raising rates well before Tuesday’s meeting. Deputy governor Andrew Hauser suggested as much in an interview with Michelle Grattan in her Politics podcast on The Conversation website a week beforehand. He stressed the risk of failing “to act decisively enough to prevent inflation staying high or even rising, and expectations of inflation disanchor[ing] …”

In the event, the RBA board decision appeared less than decisive. The vote to hike rates was decided 5-4. Bullock insisted all members agreed on the need to raise rates and disagreed simply on timing.

Many economists see it as further evidence that the RBA was, once again, behind the game. McKibbin says the bank cut rates too far and too fast last year, and left them low for too long.

The cash rate went down to 3.6 per cent last August, and stayed there until December. He says it should never have gone below 4.25 per cent.

Dr Luke Hartigan, senior lecturer in the School of Economics at Sydney University and an expert in oil supply shocks, sees similarities with events in 1973, in which Middle Eastern oil suppliers announced an oil embargo against nations that supported Israel in the Yom Kippur war.

That resulted in a prolonged period of stagflation – the simultaneous occurrence of slow growth, high unemployment and rising prices – the worst nightmare of central bankers.

Hartigan agrees with McKibbin that the RBA has not set Australia up to deal with the current crisis.

“The real problem with the bank is that they should have been back to target sooner. When you have an exogenous shock like this, it gives you a better position to start off. We’re starting in a bad position because of bad policy last year.

“Because it’s been so long since inflation has been in the target, people started to doubt the credibility of the bank, so that means it had to go even more aggressive, unfortunately.”

Others, such as The Australia Institute’s Grudnoff and independent economist Nicki Hutley, suggest the rise in inflation over recent months was likely temporary, anyway. They point out that there has been no wages breakout, unit labour costs have been declining, as has consumer demand and sentiment, and even house price growth has slowed significantly.

Hutley notes that the RBA itself acknowledged these things. She summarises this week’s RBA statement as: “We feel like we should raise rates just in case, but actually there is a whole lot of reasons why we don’t need to.”

“There are factors weighing on both sides of the equation,” says Hutley, “but there’s a lot of reasons for them to not have raised. The RBA mindset is ‘we’re not going to get surprised by inflation again’.”

The reality is that in this case there’s no avoiding it, and, as Grudnoff noted, raising interest rates will do nothing to prevent this supply shock inflation.

Luci Ellis, a former deputy governor of the RBA, now chief economist at Westpac, also suggested the bank’s concerns were misplaced. In a note this week, she said the post-meeting statement “highlighted the possibility that an extended period of high energy prices and uncertainty would degrade supply capacity and thus be inflationary. Most other observers would see that scenario as a global recession risk with rather different policy implications.”

McKibbin, however, having been on the bank board, has some sympathy for the RBA’s predicament.

“We’re setting policy under uncertainty, and we’re not necessarily picking the best policy. We’re picking the policy that does the least damage if we’re wrong,” he says.

That, at least, is pretty unarguable. A quarter of a percentage point increase in the cash rate will not do a lot of damage compared with what is coming down the track from the expanding war.

This article was first published in the print edition of The Saturday Paper on
March 21, 2026 as “Strait to the wallet”.

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