The RBA's 5-4 Split Decision Reveals a Central Bank Fighting the Wrong War

The Reserve Bank board met on Tuesday and raised the cash rate by 25 basis points to 4.10%, but the decision was anything but unanimous. Five members voted to increase, four voted to hold. That split tells you more about the state of Australian monetary policy right now than the rate move itself.

This is the second rate increase in as many months. In February, with inflation at 3.8% and the target at 2.5%, the board hiked by 25 basis points to 3.85%. Then Iran closed the Strait of Hormuz on February 28, oil went from $70 a barrel to $116 in a fortnight, petrol stations across Sydney ran dry, and Treasury's economists started modelling scenarios where inflation exceeds 5% next quarter. The board convened again in March and, by a narrower margin than most expected, pushed the cash rate higher still.

The problem is that the tool they are using was not designed for the problem they are trying to solve. Rate hikes work by suppressing demand. You make borrowing more expensive, households pull back on spending, firms delay investment, aggregate demand falls, and eventually inflation cools. But oil price shocks are supply-side events. No amount of demand suppression in the Australian economy will convince Iran to reopen the Strait of Hormuz, and that is where roughly a fifth of the world's oil transits on any given day.

The mechanics of a tool mismatch

Anders Magnusson, chief economist at BDO, put it plainly in a note to clients on Wednesday morning: "The RBA can't influence oil supply or global geopolitics. The only tool it has is the cash rate, which works by suppressing demand." That is both the central bank's strength and its constraint. When inflation is driven by domestic spending running ahead of productive capacity, the cash rate is an elegant instrument. When inflation is driven by a war in the Persian Gulf, it is the wrong tool entirely, but it is the only tool the RBA has.

The parallels with the 1970s are worth considering carefully. In October 1973, the Yom Kippur War triggered an Arab oil embargo, and Brent crude quadrupled from $3 to $12 a barrel within six months. Central banks in the United States, the United Kingdom, and Australia responded by tightening monetary policy aggressively, attempting to suppress the second-round effects of higher energy costs feeding into wage demands and broader price increases. The result was stagflation—high inflation paired with weak growth and rising unemployment. The rate hikes did not bring oil prices down; only the eventual resumption of supply did that. What the rate hikes did accomplish was a sharp contraction in economic activity, and by the mid-1970s, Australia was in recession.

We are not at that point yet, but the structure of the problem is familiar. Oil is trading at $103 as of Friday's close, down from last week's peak of $116 but still 47% higher than it was at the end of February. Treasury's modelling, leaked to the financial press earlier this week, suggests that if oil stays above $100 for the next quarter, inflation could breach 5%. If it climbs to $120, you can add another percentage point on top of that. These are not RBA forecasts—Treasury operates independently—but they inform the conversation at Martin Place, and they explain why five board members voted to tighten policy even as the economy softens.

What the dissenters saw

The four board members who voted to hold rates at 3.85% were not named in the RBA's media release, but their reasoning is implicit in the language the statement used to describe the decision. "Members noted that domestic demand is moderating," the release said, and "further tightening risks amplifying the slowdown without materially affecting the inflation driven by external energy shocks." That is as close as the RBA gets to airing internal disagreement in public.

Harry Murphy Cruise, head of economic research at Oxford Economics Australia, told this publication on Thursday that the dissenters had a point. "Oil price shocks are a central bank's worst nightmare," he said. "The only thing that will bring oil prices down is more supply flowing through the Strait of Hormuz—and no amount of interest-rate hikes will convince Iran to reopen that passage." His firm's baseline scenario assumes oil settles around $90 by mid-year, which would allow inflation to drift back toward 3.5% without further tightening. The risk, he said, is that the RBA overtightens into a supply shock and tips the economy into a contraction that was entirely avoidable.

Deputy Governor Andrew Hauser offered a counterargument during a podcast appearance last week, recorded before the March meeting but released Wednesday. "High inflation is toxic," he said. "If we allow it to become entrenched in wage-setting and price-setting behaviour, the cost of bringing it back down later will be far higher than the cost of acting now." That is the classic central banker's dilemma: act too early and you risk unnecessary pain; act too late and you risk losing credibility. The five-member majority chose to act.

How markets are pricing the next move

Overnight indexed swaps, which reflect market expectations for the cash rate, are now pricing in a 60% probability of another 25-basis-point increase at the April meeting. That is up from 45% before Tuesday's decision. The Australian dollar strengthened by half a cent against the US dollar on the news, closing at 0.6520 on Friday, as traders reassessed the interest-rate differential between the two currencies.

Fixed-income markets moved more sharply. The yield on three-year Australian government bonds rose 12 basis points to 3.92%, the highest level since January. That suggests bond traders believe the RBA will continue tightening even if growth slows, prioritising inflation control over near-term output. The spread between bank bill swap rates and the cash rate widened slightly, indicating that funding costs in the interbank market are rising faster than the policy rate itself—a signal that liquidity is tightening at the margin.

Retail borrowers will see the increase reflected in variable mortgage rates within days. The major banks typically pass on the full 25 basis points, which adds roughly $80 per month to repayments on a $500,000 loan. For households already managing higher petrol and grocery costs, that compounds the squeeze. The RBA's own consumer sentiment index fell 3.2 points in February, before this latest hike was announced, and the March reading is likely to show further deterioration.

The question no one can answer

The central question facing the board at the April meeting, and possibly beyond, is whether the inflation they are trying to suppress will prove transitory or persistent. If oil prices fall back to $80 within a month or two—either because Iran reopens the strait under diplomatic pressure or because global demand weakens faster than expected—then the March rate hike will look like an overreaction, and the four dissenters will have been vindicated. If oil stays elevated and inflation expectations start drifting upward in wage negotiations and pricing decisions, then the five-member majority will have been proven right.

The trouble is that the answer depends almost entirely on events in the Middle East, which the RBA cannot influence and cannot predict with any confidence. That is not a comfortable position for a central bank accustomed to steering the economy with a high degree of precision. The cash rate is a powerful instrument when the transmission mechanism is clear, but in the present environment, it resembles a sailor adjusting the trim on a yacht that is being blown off course by a gale. The adjustments matter at the margin, but the wind is what determines where you end up.

What comes next

The RBA will publish the full minutes of the March meeting on Tuesday, March 24, and those minutes will provide more detail on the split decision and the arguments advanced by both sides. Market participants will scrutinise the language for any hint of how the board might vote in April. Governor Michele Bullock is scheduled to testify before the House economics committee on March 28, and that hearing will offer another opportunity to probe the thinking behind the decision.

In the meantime, the oil market remains the primary variable. If the situation in the Persian Gulf deteriorates further, or if another supply disruption emerges elsewhere, the RBA may find itself hiking rates again in April even as growth softens. If oil prices ease, the board may pause and wait for the lagged effects of the February and March increases to work through the economy. Either way, the central bank is operating with less control over the inflation outlook than at any point since the commodity supercycle of the mid-2000s, and that is reflected in the fact that the March decision was not unanimous.

The last time the RBA board split on a rate decision was September 2007, when inflation was accelerating ahead of the global financial crisis. That split foreshadowed a period of heightened uncertainty and rapid policy reversals. Whether the March 2026 split will prove similarly ominous remains to be seen, but it is a signal worth noting.