It's unclear whether the US-Israeli attacks on Iran will amplify or dampen inflation, the head of Australia's central bank says.
Reserve Bank governor Michele Bullock said the bank was closely watching events in the Middle East but it would take some time to make sense of their impact on domestic inflation.
"It’s too early to say what the impact will be. Events are moving rapidly and there are different ways this can play out," she told the Australian Financial Review Business Summit on Tuesday.
"A supply shock could, for example, add to inflation pressures. And the potential implications for inflation expectations are something we are very alert to.
"But at the same time, a prolonged impact on energy markets could have adverse effects on global economic activity and result in downward pressure on inflation. It is not obvious how this might play out."
Crude prices spiked by up to 13 per cent on Monday after conflict in Iran - one of the world's largest oil producers - also threatened to shut off supplies from other Middle Eastern nations.
Given oil's role as an economy-wide input, a price surge threatens to have an outsized impact on global inflation, which is already running well above the Reserve Bank's target.
In the worst-case scenario - in which the US becomes mired in a prolonged conflict with Iran and oil supplies are disrupted for longer - oil prices could double to about $US150 a barrel, AMP chief economist Shane Oliver said in a research note.
He ascribed a 40 per cent probability to such a scenario.
Ms Bullock admitted the bank got it wrong when it assessed supply and demand in the economy were coming back to balance in 2025, prompting it to cut interest rates.
It misjudged how strong private demand would be in the second half of 2025 and overestimated the economy's supply potential, she said.
But data released since the Reserve Bank hiked interest rates in February had supported that decision, Ms Bullock said.
Jobs market indicators remained tight and it was uncertain whether financial conditions were restrictive enough to bring inflation back to target in a reasonable time, she said.
"We think a large part of the unexpected increase in inflation since the middle of last year was due to sector-specific demand and price pressures that we expect to ease in coming quarters," she said.
"But economy-wide capacity pressures in the economy are also playing a role and, overall, we think underlying demand in the economy is further from its supply potential than we had assessed six months ago."
The Reserve Bank's forecast showed modelling the direction of the economy was hard enough without geopolitical flashpoints.
Data can send mixed signals.
Hard-to-foresee shocks such as the COVID-19 pandemic and global conflict made it important for the bank to supplement its models by listening directly to households and businesses, Ms Bullock said, highlighting how murky setting monetary policy could be.
