MNI INTERVIEW: RBA Should Move Fast Against Oil Shock-McKibbin

The Reserve Bank of Australia should be prepared to move early to lift the cash rate to contain inflation and pre-empt a potential oil-driven supply shock, though it is unlikely to make any dramatic shift in its monetary policy strategy in response to the Iran conflict soon, former board member Warwick McKibbin told MNI.

McKibbin, who served on the RBA board from 2001 to 2011, said policy settings—with the cash rate at 3.85%—were already too accommodative before the latest escalation in the Middle East, which could significantly disrupt global oil markets and slow global growth. He argued the rate should be closer to 4.2%, which markets have not priced in until August. 

“We’re well below that, so it’s a tough position, but that’s the position that they’re in, in my view," he said. "I would continue with whatever strategy they had before last weekend. I would just be making clear to people the reason you’re doing what you’re doing, and what you might do differently if things changed."

He argued the RBA would ideally need a higher cash rate before a supply shock feeds through to prices and weakens global growth, describing 4.2% as a rough neutral benchmark based on nominal growth. With the economy expanding at a little over 1% and inflation around 3.5%, a back-of-envelope calculation suggests nominal growth near 4.5%, implying a policy rate “with a four in front of it, at least.”

McKibbin, who correctly called the RBA's February hike last year, said the current environment echoes 2022 ahead of Russia’s large-scale invasion of Ukraine, but warned the present shock could prove more disruptive given the Middle East’s central role in global oil and gas flows. (See MNI INTERVIEW: RBA At Risk Of Q1 Hike - McKibbin) “It’s a bigger shock … and more geopolitically risky,” he said, citing threats to major energy producers across the region.

MONETARY RESPONE

Central banks must respond to the information in hand rather than delay tightening in anticipation of a potential downturn, he stressed. Drawing on his experience before the global financial crisis as an RBA board member, he said it would have been a mistake not to raise rates in 2007 simply because risks were building abroad.

“You respond to the information that you know about. We know that we’re outside the band on inflation, and we know we have to control inflationary expectations,” he said, while remaining ready to “spin on a dime” if conditions shift sharply.

Scenario analysis could be critical, he added, pointing to energy price shocks, disruptions to global production networks and heightened uncertainty as the three main transmission channels. He also warned of potential financial market fragilities, particularly in highly-valued U.S. technology stocks, that could amplify the shock.

"It’s hard to model exactly where the risks are, but you know they exist," he said, likening current tech valuations to 2000's dot com bubble. "The biggest concern is how markets respond, particularly pricing. For Australian markets, most products seem reasonably priced, but in the U.S., high valuations and the large flow of liquidity between companies—lending to one another to buy assets—creates fragilities that worry me." 

The key for policymakers is not identifying the optimal outcome but choosing the path that does the least damage under a range of uncertain scenarios, McKibbin said. "If you didn’t know there was a war in the Middle East today, you’d be hiking interest rates, in my view,” he said, arguing excess demand remains in the economy absent major fiscal consolidation.