Further escalations in conflict between the Russia and the west is emerging as Australia's biggest economic risk, the central bank has warned.
Delivering a speech to the Australian Financial Review summit on Tuesday, Reserve Bank governor Philip Lowe said the unfolding Ukraine crisis was taking over from the pandemic as the major uncertainty facing the nation's economy.
Dr Lowe said that despite Australia being likely to see a rise in its terms of trade, higher commodity prices for imports such as oil would eat into household balance sheets and drive up the cost of living.
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He said it was still early days but the RBA was closely monitoring the conflicts and its potential impacts on rising inflation.
"This war is first and foremost a catastrophic event in human terms, but it is also a new major risk to the global economy," Dr Lowe said.
"It is difficult to know what the full implications are, but from today's viewpoint, the main economic effects stem largely from higher commodity prices."
Dr Lowe noted the pandemic still posed a risk to the economic recovery, particularly around ongoing supply chain problems.
The RBA said supply chain constraints were recovering prior to Russia's invasion, however the ongoing crisis was likely to put upward pressure on supply side inflation and influence the central bank's existing monetary policy settings.
Australia's cash rate sits at 0.1 per cent with the RBA flagging it would not consider hiking the rate until sustained inflation is within its target band of 2 to 3 per cent.
December 2021 consumer price index figures printed headline inflation at 3.5 per cent, sparking the market to believe an interest rate rate hike is likely to occur later this year.
Dr Lowe admitted during his speech a bump up in interest rates later this year is a plausible scenario, but highlighted Ukraine and labour costs in Australia were major factors still being assessed.
"The war in Ukraine and the sanctions against Russia have created a new supply shock that is pushing prices up, especially for commodities," he said.
"This new supply shock will extend the period of inflation being above central banks' targets."
Sustained higher inflation would prompt a greater monetary response by the RBA, but Dr Lowe warned moving too early could dent the recovery from the COVID-19 shock.
"I recognise that there is a risk to waiting too long," he said.
"But there is also a risk of moving too early. Australia has the opportunity to secure a lower rate of unemployment than has been the case for some decades. Moving too early could put this at risk."
The governor also said Australia is a major exporter of the majority of commodities facing price surges, which will lead to an increase in the country's terms of trade and national income.
Dr Lowe's comments coincided with the release of the Westpac-Melbourne Institute's monthly consumer sentiment report, which found a dip confidence due to the Ukraine conflict, floods and rising household costs.
The index fell 4.2 per cent to a position of 96.6 in March, which down from 100.8 in February and reflects pessimists outweigh optimists about the future state of the economy.
Westpac chief economist Bill Evans flagged it was the weakest print in the survey since September 2020 and was largely being influenced by heightened concerns around inflation.
"The war in Ukraine; the floods in south-east Queensland and Northern NSW; ongoing concerns about inflation and higher interest rates were all likely to impact confidence, although the size of the decline is still notable," Mr Evans said.
"But it is inflation news that has really exploded. A year ago, just 8.6 per cent of respondents recalled news on inflation. That proportion jumped to 38.7 per cent in March, a fourteen year high."
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