Key insights from the week that was.
In Australia, the Q1 CPI report provided the first official estimate of the impact on local prices of the Middle East conflict. Headline inflation accelerated sharply to 1.4% (4.1%yr) in Q1 on the back of a 33% surge in auto fuel prices in March alone. Fortunately, a large portion of this spike has since unwound following the fuel excise cut, although fuel prices remain materially above the pre-conflict level.
While there were some signs of price pressures across home-building, vehicle repair and insurance, it is too early to detect, let alone accurately assess, evidence of pass-through. That said, underlying trimmed mean inflation still rose 0.8% in Q1, with annual growth at 3.5%yr, a full percentage point above the mid-point of the target. Notably, March’s data pre-dates the wide range of price increases reported anecdotally for building products and other items which came into effect in April.
Following the CPI release, Chief Economist Luci Ellis reaffirmed our call for the RBA to increase the cash rate by 25bps to 4.35% at the May policy meeting. The combination of an elevated starting point for inflation and imminent risk of pass-through will compel the RBA to act pre-emptively to contain inflation expectations. Next week’s voting split, updated staff forecasts and the tone of communications will be informative on the baseline policy outlook and risks. For now, we retain our base case of another two hikes beyond May, in June and August, taking the cash rate to a peak of 4.85%.
The combination of higher inflation, slower growth and rising unemployment is also fostering a complex macroeconomic backdrop for the 2026/27 Federal Budget, due May 12. A full preview will be published next week, but our preliminary note sets out our central expectation that commodity price windfalls are likely to more than offset spending pressures and result in a net improvement in the budget’s bottom line over the forward estimates.
Offshore, at the beginning of the week the Bank of Japan held its policy rate at 0.75% in a 6-3 vote. Updated forecasts highlight the risk of stagflation, with FY26 growth revised sharply lower to 0.5% (from 1.5%) and core inflation now expected to remain above 2% through to FY28. With Japanese firms increasingly willing to pass on costs, the Middle East conflict risks amplifying domestic inflationary pressures.
The BoJ remains focused on restoring the policy rate as an effective policy lever. Further hikes were signalled, but the timing left open. With policy settings still considered accommodative and a weak yen threatening import inflation, we anticipate the next hike to occur in June, though there is a risk it is delayed to July. The Financial Statements Statistics update due on 1 June will be an important release to gauge firms’ response to the crisis and the implications for both inflation and activity.
In the US, the FOMC then kept the stance of policy unchanged at its April meeting. The tone of the statement was balanced, with a sanguine view on GDP growth and the labour market and inflation simply characterised as “elevated”. The statement also noted that “the Committee is attentive to the risks to both sides of its dual mandate”, while Chair Powell remarked in the press conference that, in his view, policy is in a good place to take time to monitor conditions, being at the “high end of neutral, perhaps mildly restrictive”. Governors Hammack, Kashkari and Logan also showed greater concern over inflation than the labour market at this meeting, wanting to maintain the target range for the federal funds rate and signal that a hike was as likely as a cut on current information.
The Bank of Canada also kept its policy stance unchanged. The conflict in the Middle East and US trade policy were called out as sources of uncertainty for the global economy. But overall, the outlook for Canada’s economy was viewed as little changed from January. Assuming a protracted resolution to the Middle East conflict into 2027, GDP growth is expected to strengthen through 2027-2028 and inflation to turn back towards the 2%yr target from 3%yr in the near term, allowing the Bank of Canada to remain on hold.
Thereafter in Europe, the ECB Governing Council opted to maintain its current policy stance. The ECB acknowledged that “upside risks to inflation and downside risks to growth have intensified” and the merits of a rate hike were discussed, but developments to date were not sufficient to convince the Governing Council to take immediate action – the decision to hold was unanimous. At its previous meeting in March, the ECB presented two downside scenarios alongside its baseline. In the April press conference, President Lagarde was reluctant to discuss the details of those scenarios, noting simply that conditions are diverging from March’s baseline and the upcoming six weeks “will be the right time” to assess the economy “in order to make an informed decision”. Her comments appeared carefully chosen to signal openness to a rate increase in June. Therefore, barring any major changes in the dynamics of the Middle East conflict, we continue to believe that a 25bp policy rate hike is the most probable outcome at the next meeting.
The Bank of England’s April meeting also unfolded broadly as expected, the MPC voting 8-1 to keep the policy rate at 3.75%. Chief Economist Hew Pill was the sole dissenter, preferring “a prompt but modest hike in Bank Rate” to contain the risk of second-round inflationary effects. The policy statement maintained a hawkish bias, however, emphasising the potential impact of the energy price shock – its scale and duration – on UK inflation and the committee’s readiness to act to ensure inflation returns to the 2% target. Policy makers also showed concern over economic growth and the labour market, with slack increasing prior to the conflict.
Risks to the economic outlook were illustrated using three alternative scenarios, differentiated by oil and gas price assumptions and the persistence of second-round inflation effects. In the first two scenarios, the Brent oil price averages $108 in Q2 2026 then decreases at different speeds. Both scenarios showed headline inflation peaking above 3.5%yr this year before easing in 2027. Importantly, the Governor emphasised that, if the economy evolves in line with these scenarios, further policy tightening may not be required – the removal of the circa 50bp of easing priced before the conflict potentially sufficient to bring inflation back to the 2% target. The committee judged that the most severe scenario – where Brent averages $127 this quarter and remains above $100 well into 2028 – would likely require “a forceful tightening in monetary policy”, however. The Governor declined to specify what interest rate changes this would entail, but noted the need to act quickly to minimise second-round effects. Bank Rate hikes this year are therefore not guaranteed, but with Brent Oil surging as much as 20% this week to a peak around USD126 (now USD114) as the US and Iran remained at an impasse, conditions may eventually become too close to the BoE’s most severe scenario for the MPC to ignore. We continue to expect a Bank Rate hike at the next policy meeting in June, with further tightening possible, but dependent on evolving circumstances.
 in Q1 on the back of a 33% surge in auto fuel prices in March alone. Fortunately, a large portion of this spike has since unwound following the fuel excise cut, although fuel prices remain materially above the pre-conflict level.){kind=link}