The RBA will hike rates again but inflation is testing the bank’s most valuable asset

Last weekend I paid $70 for a rosemary and garlic butterflied chicken at my local farmers’ market. Although it was delicious, I mention this not to show off. I am mortified that I failed to check the price before getting drawn into a conversation with the farmer about how the unusually warm winter had increased chicken sizes.

Still, it proves that $70 chickens exist, and other customers paid just as much.

I cannot say how much of the price reflected higher feed and fuel costs, packaging or garlic. But it appeared to have more to do with supply pressures linked to geopolitics and bird flu precautions than surging demand from discerning chicken lovers. There was no queue, let alone a bidding war.

It raises important questions for the Reserve Bank. How does it fight inflation when price rises are not driven by strong demand? When it cannot change agricultural conditions or the quantity of oil coming from the Middle East, how does it convince us it has inflation under control?

Its credibility depends on it, and credibility is a central bank’s most valuable asset.

Unfortunately, the answer is to curb demand by a fourth rate rise this year and possibly a fifth, to slow an economy that grew by just 2.1 per cent in the year to the June quarter.

The Reserve must respond not only to global supply constraints from wars, weather and energy prices but also to domestic demand in food, housing and healthcare. Chicken prices may not be front of mind, but annual increases of 5.6 per cent for meat and seafood, 4.9 per cent for medical and hospital costs and 4.8 per cent for education will be. It must also prevent the primary effects of higher prices from overseas events becoming embedded in second-round effects such as rising inflation expectations and wage-price dynamics.

Mortgage holders’ budgets need to be squeezed, savings encouraged, asset-price growth suppressed and the Australian dollar supported. The RBA has tried the cautious approach: modest rate rises designed to lower inflation while preserving as much strength in the labour market as possible. It has not worked.

The central bank has good reason to proceed carefully. Monetary policy is blunt and works with a lag, so February, March and May’s rate rises are still flowing through the economy. Raising rates too far risks hurting the jobs market, challenging the second part of its mandate: to maintain full employment. But that is a path that the RBA is willing to take. Governor Michele Bullock said this week that the current 4.5 per cent unemployment rate probably needs to sit between there and 5 per cent to get the job done.

Core inflation, measured by the trimmed mean, was growing at 3.6 per cent in the year to July and has been above the RBA’s 2 to 3 per cent target for nearly 70 per cent of the time since 2021. Inflation has repeatedly exceeded its forecasts, while the expected return to the 2.5 per cent midpoint has slipped from mid-2027 to early 2028.

Since the Reserve’s August 2026 Statement on Monetary Policy, domestic petrol prices have again risen above $2.20 a litre. Data centre construction has added demand to a sector already stretched by record government infrastructure, housing and energy-related building.

“Although growth in the Australian economy is slowing, some of these upside risks to inflation appear to be materialising,” Bullock told a parliamentary hearing last week.

The RBA is not yet facing a credibility crisis. But the longer the headline inflation rate, which is currently 3.5 per cent, remains above target and the return to 2.5 per cent is delayed, the greater the risk households and businesses abandon the target as a reliable guide.

Credibility anchors expectations, helping to deliver low inflation. Businesses are less likely to build precautionary margins into prices, while workers are less likely to seek larger pay rises to cover household basics. That reduces pressure on firms to pass on higher labour costs to consumers.

Inflation still feels far from under control. Short-term inflationary expectations are elevated and unusually far above the target band. The RBA’s liaison program shows many firms expect above-average wage growth over the coming year, with a growing share anticipating stronger wages. Long-term expectations remain anchored but for how long? Rising global long-term bond yields are sending several signals, including that the inflation outlook is not good.

The Reserve Bank appears alert to the threat to its credibility. After holding rates steady in August, it stepped up public appearances by senior officials, with eight in September so far. That is its busiest month this year. Assistant governor Sarah Hunter has stressed the central bank’s limited tolerance for stronger inflation pressures, while deputy governor Andrew Hauser has said further tightening remains possible.

The decision rests with the Monetary Policy Board, but the RBA’s recent language suggests the staff are pushing for a rate rise next week, with a further increase in November still on the table.

Mortgage holders will not want to hear it. But if the RBA waits too long to convince households and businesses it is serious about inflation, households and the broader economy will ultimately bear the cost of restoring that credibility.

My $70 chicken was not expensive because Australians had suddenly developed an insatiable appetite for poultry. Yet the bank may still need to lean harder on households to stop poultry inflation becoming embedded across the economy.

The bank cannot produce more oil, fertiliser or chickens. But it can prevent today’s supply shocks becoming embedded in expectations about tomorrow’s prices and wages. That is why it must raise rates next week and remain open to doing so again in November.

Cherelle Murphy is the chief economist of EY, Oceania.

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