Australia’s Chalmers says Iran war could raise inflation, weigh on GDP
Australia’s Treasurer Jim Chalmers said on Wednesday that Iran war could add a further quarter of a percentage point to headline inflation and double the negative impact on Gross Domestic Product (GDP).
Key quotes
Treasury modelling two scenarios - oil stays at $100 per barrel for h1, or hits $120 and takes three years to get back to pre conflict price.
Compared to treasury modelling a week ago, latest figures suggest Iran war could add a further quarter of a percentage point to headline inflation and double the negative impact on GDP.
Latest estimates see headline inflation peaking 0.75 of a percentage point higher in the short term scenario and 1.25 percentage point higher in the prolonged one.
In the short term case, output would be 0.2% lower around the middle of this year.
In both scenarios prospect of inflation peaking in the high 4s or even higher this year is very real.
In prolonged scenario, gdp would be 0.6% lower in 2027 and even by 2029 would still be below where it would have been without the conflict.
Around half of the impact to GDP is due to the impact of higher oil. The other half is due to broader consequences.
Market reaction
At the time of writing, the AUD/USD pair is up 0.22% on the day at 0.7120.
Australian Dollar FAQs
One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.
The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.
China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.
Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.
The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.
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