Australia’s inflation genie is back out of the bottle as energy shock adds pressure

Australia’s inflation challenge has resurfaced faster than expected, with the local economy growing above its sustainable “speed limit” just as higher global energy prices add further pressure, Commonwealth Bank Head of Australian Economics Belinda Allen says.

Inflation in Australia began reaccelerating well before the latest spike in fuel prices, reflecting an economy running too hot relative to its underlying capacity, Allen said on the latest episode of the CommBank View: Economics & Markets podcast.

“Only around 12 months ago we’d effectively declared victory on inflation,” she said.

“But inflation picked up again in the second half of last year because growth has been running above what the economy can sustainably handle.”

Demand running ahead of supply

Rather than being driven by a single factor, inflation pressures are broad‑based and being felt across the economy, in sectors spanning goods, services and housing, Allen said.

“About half of the inflation basket [the hypothetical ‘basket’ of goods the ABS uses to measure price movements] is rising by more than 3 per cent,” she said. “That tells us this is not a narrow problem.”

Stronger household spending in late 2025 lifted demand for those goods and services and was supported by improving incomes, earlier interest rate cuts and tax relief. Public sector spending also remained resilient, while business investment picked up, particularly in data centres,” Allen said.

At the same time, the supply side of the economy has struggled to keep pace with the demand, held back by a shortage of workers with the right skills and weak productivity.

“There’s no single culprit,” Allen told podcast host Mandy Drury. “It’s the combination of strong demand and insufficient supply that’s driving inflation higher.”

On Wednesday the ABS announced the Consumer Price Index (CPI) rose 3.7% in in the 12 months to February, down from a reading of 3.8% for January. The biggest contributors to annual inflation in February were housing (+7.2%), food and non-alcoholic beverages (+3.1%) and recreation and culture (+4.1%). Trimmed mean inflation - the RBA's preferred measure - remained unchanged at 3.3% for February, the ABS reported.

Energy prices add new inflation risk

Meanwhile, rising global energy prices caused by the conflict in Iran risk adding to inflation pressures across the economy, particularly if higher transport costs are passed on by more businesses.

“We’re already hearing from businesses that they’ll need to raise prices,” Allen said. “Energy costs don’t just affect petrol - they flow through to food, freight and manufactured goods.”

CommBank spending data shows household consumption has remained resilient in early March, but Allen expects momentum to slow as higher prices and interest rates take effect.

“We were already expecting consumer spending to moderate into 2026. The key question is the size and timing of the slowdown, and confidence will be critical.”

Why the RBA is tightening again

The Reserve Bank of Australia’s recent rate hikes were driven by domestic inflation pressures rather than offshore developments, Allen said.

“The RBA lifted rates because inflation was already rising,” she said. “The energy shock only adds to the risk that inflation expectations become entrenched.”

With inflation elevated and the supply of labour still tight, the RBA remains focused on its inflation mandate, even as higher rates increase pressure on households.

What different Iran scenarios could mean

Allen outlined three potential paths for the conflict in Iran, each with very different implications for inflation and growth.

A rapid de-escalation of the conflict would see oil prices fall, limiting the war’s inflation impact. A prolonged but contained conflict would keep energy prices higher, slowing growth and pushing inflation higher for longer.

A severe escalation, including disruption of energy infrastructure and transport through the Strait of Hormuz, would represent a worst case outcome.

“In that scenario, oil prices could move closer to US$150,” Allen said. “The pace of Australian economic growth could effectively halve, while inflation would move well above 5 per cent.”

While Australia could benefit from stronger energy export revenue, Allen cautioned the net impact would still be negative for Australian households.

Resilience now, risks building

On the positive side, those same Australian households are, on average, entering this period of uncertainty with stronger financial buffers than in previous economic cycles. Those buffers include higher savings, with many mortgage holders choosing not to reduce their repayments through last year’s interest rate cuts.

“That resilience should help smooth spending in the near term,” Allen said. “But over time, higher costs and interest rates will weigh on consumption.”

A delicate balancing act

Uncertainty is likely to remain a defining feature of the economic outlook, driven by geopolitics, policy decisions and structural shifts such as the energy transition and artificial intelligence,” Allen said.

“The Australian economy is entering this period from a position of relative strength, but getting the inflation genie back into the bottle will require careful balancing across monetary and fiscal policy,” she said.