Inflation to linger for next 6 months despite Hormuz negotiations

With the conflict in the Middle East hiking oil prices and causing ripple effects on the economy, economists rule out the potential of an Australian or global recession, but emphasise that inflation will remain for at least another six months.

US crude oil has fallen to around US$112 since Pakistan secured a two-week extension of the deadline for Tehran to reopen the Strait of Hormuz, postponing Trump’s deadline of 8pm (EST) on Tuesday, 8 April.

AMP deputy chief economist Diana Mousina said that oil prices may take a while to normalise, with higher inflation likely for approximately six months, with slowed consumer spending and lower GDP growth.

In the wake of the extension of the opening, CommBank found that, along with the fall in oil prices, the S&P 500 index erased a 1.2 per cent drop, US bond yields and the US dollar both fell.

As reported by Accounting Times, on 31 March, the federal government confirmed that it would halve the fuel excise from 52.6 cents per litre to 26.3 cents per litre from 1 April to 30 June.

“Longer Middle East disruption lifts peak prices for oil and gas, lengthens recovery. Infrastructure damage exacerbates the shock. Brent oil is now expected to peak at an average $120/bbl in the second quarter and Japanese LNG prices at $26mmbtu,” said Luci Ellis, chief economist at Westpac Group.

“Heightened inflation will remain an acute risk while transit and supply-chain disruptions persist,” Westpac Group economists said.

Inflation

First-round impacts to inflation will arise from the increase in fuel prices, which will add 1.2 percentage points to March’s monthly headline inflation and 0.7 percentage points to the June quarter, AMP said.

“Second-round impacts will be felt in the June quarter from other products that use oil and its by-products, including gas, aluminium, fertilisers, pesticides, chemicals, industries that produce and move goods like manufacturing, agriculture and transport (especially air and road) and now even service industries that are adding a “fuel surcharge” for increased costs to travel,” AMP added.

AMP expected annual inflation of 4.3 per cent in the March quarter, 5 per cent in June, and 4.3 per cent by December, with a trimmed mean of 4 per cent in June and 3.5 per cent in December.

It also predicts another RBA cash rate increase in May to 4.35 per cent and a chance of another lift later in the year, which translates into a higher chance of rate cuts in 2027 as GDP growth slows.

“This could be met with interest rate cuts sometime next year, as demand takes a hit from restrictive interest rates,” AMP said.

Westpac Group also estimates two additional cash rate hikes, with a peak of 4.85 per cent and a later reversal.

“We now expect 25 basis-point rate hikes at the 16 June and 11 August decisions, in addition to the 25 basis-point hike we already expected at the May meeting. The peak for the cash rate is now expected to be 4.85 per cent,” Ellis said.

“The halving of fuel excise, announced by the national cabinet [on 31 March], reduces the near-term outlook for headline CPI inflation, but a peak of 5.4 per cent year-on-year in the June quarter remains likely,” Ellis added.

“We expect unemployment to peak around 5 per cent, somewhat higher than the 4.7 per cent peak we flagged last week,” Westpac Group said.

“Headline inflation will dip below 2.5 per cent by mid-2027 and will remain in the lower half of the 2–3 per cent target range through to 2028. Trimmed mean inflation will take a little longer to decline, but will be back in the target range in 2028,” the bank added.

Household spending

According to the ABS, the Monthly Household Spending Indicator (MHSI) rose by 0.3 per cent in February, which is in line with its average monthly pace over the past two years, Westpac Group said.

This puts the MHSI up 4.6 per cent on a year ago, CommBank added.

This was driven by a 0.5 per cent increase in household spending on discretionary goods month-on-month, “driven by increased spending on recreational and cultural services, air passenger and sea transport, and accommodation services,” the Australian Bureau of Statistics (ABS) said.

Westpac Group’s forecast spending decline of 0.2 per cent month-on-month would result in annual growth of 4.2 per cent year-on-year.

According to AMP, the impact of higher oil prices on petrol prices is equivalent to about 3 per cent of consumer spending, with petrol prices up by about 45 per cent month-on-month.

Elevated household wealth has been a driver of consumer spending in recent years, with a nearly 10 per cent increase in the net worth of average households year-on-year last year ($1.8m) and a 60 per cent increase since the pandemic, AMP added.

AMP said that the longer-term impact of higher oil prices is lower spending growth in the economy, revising down GDP growth forecasts to 1.6 per cent by December, which is in line with population growth tracking at 1.6 per cent year-on-year; however, it does not forecast an Australian or global recession.