How the Iran war could hit Australian inflation, interest rates and property prices

US President Donald Trump has suggested the war with Iran will be over in less time than it takes to complete a bathroom renovation.

The Middle East has a way of mocking such expectations.

Casualties are mounting daily as the US-Israeli strikes across Iran intensify and the conflict expands into other Middle East countries.

Prime Minister Anthony Albanese has thrown his support behind the US’ actions but while the conflict is 11,000 kilometres away, the economic implications for the Australian economy could be enormous.

When it comes to GDP, inflation and property price forecasts, the ubiquitous caveat following any prediction invariably goes along the lines of, “subject to there being no major geopolitical developments”.

Is the war in Iran that ‘major geopolitical development’?

It all depends on its duration and whether Mr Trump’s assertion that it will all be over in four or five weeks morphs into four or five months or years.

In 2003, another Republican leader, George W Bush, declared combat operations in Iraq was “Mission Accomplished”. The war continued for nine more years.

Vladimir Putin thought it would take four days to steamroll Ukraine and take Kiev. Four years later there is still no end in sight to the deadly conflict.

Prolonged conflict or economic aberration?

If the latest conflagration in the Middle East becomes another geopolitical and conflict quagmire, Australia’s attempts to rein in rising inflation will be in peril. Interest rates would come under pressure and borrowers would likely bear the brunt of that financial battle.

If shipping in the Strait of Hormuz in the Persian Gulf is restricted or blocked, fuel prices could soar and freight costs for other products could be impacted. A $US40 a barrel spike in oil prices could add 40 cents a litre to petrol prices.

RBA Governor, Michele Bullock, has already expressed her dismay.

“The past few days have seen a significant escalation in conflict and instability in the Middle East, which is deeply concerning.

“These events are a timely reminder that in this world of geopolitical uncertainty, things can change quickly.

“It’s too early to say what the economic impact will be, events are moving rapidly and there are different ways this can play out; we will take some time to make sense of what it could mean for inflation here.

“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,” Ms Bullock said Tuesday (3 March).

Professor Vito Mollica, Deputy Dean Research and Innovation, Macquarie University, said that if the conflict is short‑lived, the impact is more likely to resemble other brief geopolitical flare‑ups.

He told API Magazine that if it persists for months and materially disrupts oil supply or key shipping routes and their associated insurance and freight costs, the inflation impulse is more likely to become entrenched and the growth hit more pronounced, with a broader global downturn risk.

“Australia exports energy coal and gas, but we still pay global oil prices at the bowser.

“Higher petrol and diesel costs feed straight into transport and freight, so it lifts costs across the economy, including food and essentials.”

“If it’s short-lived, it’s mostly a temporary headline CPI pop but if it disrupts oil supply or key shipping routes for months, it can become more persistent and start to bite growth as well,” Professor Mollica said.

In the past five or so years, major economies (and their share markets) have shrugged off the type of major developments like the Ukraine War, Covid, Arab Spring uprising, unpredictability in the US and more, that might previously have caused major economic ructions.

Will Iran prove similarly inconsequential to global economies?

Professor Peter Robertson, Dean and Head of the Business School, University of Western Australia, told API Magazine that there is a chance this conflict proves more economic hiccup than hurricane.

“Oil is critical – albeit less so than it used to be, and governments and central banks have more experience at managing economic cycles than was the case in the 1970s and 80s, so it’s likely this shock will be shrugged off relative to those experiences.

“Nevertheless, oil remains critical and Iran is more important to the world economy than Ukraine.

“When bond markets started responding to Trump’s tariffs on China, he pulled back so ultimately that potential disruption was mitigated so, if that happens in Iran, I think the economic risks and costs will be moderate but not severe.”

Oiling the wheels of inflation

The flow-on effects of restricted oil supply from the Gulf are less dependent on Iran’s output than on shipping traffic through the Strait of Hormuz.

Although OPEC nations hold an estimated 3.5 million barrels per day in spare production capacity, theoretically sufficient to compensate for the loss of Iran’s 1.5 million barrels per day of exports, that buffer would be largely irrelevant if the Strait of Hormuz were closed.

There’s no shortage of countries that have fallen into chaos in the wake of attempted regime change and, with much of Iran’s leadership killed in the latest strikes, there is now a very real chance of Iran joining the likes of Libya, Iraq, Syria and Afghanistan among states that have failed after US intervention or conflict involvement.

Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP, said that if the current war drags on it could mean a bigger and much longer disruption to oil supplies, conceivably resulting in a doubling in oil prices to around $US150/barrel, which could drive a sharp fall in shares and surge in inflation.

Whether the RBA would look beyond such an inflationary spike is yet to be seen, and Ms Bullock said such unpredictability cannot be pre-emptively addressed.

“These types of uncertainties are complex because there are many ways that events could unfold and so they can’t be easily captured in our models.

“Instead, we must ensure we can position monetary policy to respond if needed.

“With the cash rate currently at 3.85 per cent, and the economy closer to balance than it was a few years ago, we believe we are well positioned for such a response if it were to be required.”

Professor Robertson said the RBA would likely base interest rate decisions on what they see as core underlying trend in excess spending, rather than supply side shocks.

“The RBA will not treat these price shocks as inflation, but the shocks have nevertheless made it much harder for them to manage inflation because increasing interest rates are now having a more severe impact on living costs and it’s harder to gauge the extent to which price expectations remain ‘unanchored’,” he said.

Property prices could be pressured

The RBA next meets on 17 March.

Professor Mollica said the central bank could become more hawkish if higher fuel costs permeate the economy for long enough to lift underlying inflation, or if the conflict materially disrupts supply chains and keeps energy and freight costs elevated.

“Historically, the RBA looks through one-off price shocks unless they spill into underlying inflation via broader prices, wages and expectations.

“The recent Business Outlook Scenario Survey led by Macquarie University researchers suggests Australian businesses were already concerned with inflationary pressures in the next 12 months, with the team’s analysis suggesting businesses were already preparing to pass on 20 to 40 per cent of those anticipated price increases now, and that was prior to the Iran-Israel-US conflict starting.”

History shows conflicts in the Middle East have a habit of lasting longer than first anticipated. If oil prices were to surge and remain elevated for months rather than weeks, the inflation pulse could prove more persistent, complicating the RBA’s path and placing renewed pressure on borrowers.

Higher inflation and elevated interest rates could dampen borrowing capacity and housing demand, putting pressure on property prices. However, if the economic impact proves short-lived, housing markets may remain resilient, as they have during other recent geopolitical shocks.

For Australian households and property markets, the real risk is not the headline shock, but the duration.

In geopolitics, as in economics, it is rarely the initial spark that does the damage but how long the fire burns.