Is Australia's low unemployment rate about to become a thing of the past? The recent conflict in the Middle East has sent shockwaves through the global oil market, causing a significant surge in the prices of crude oil, gas, and fertilizers. This has, in turn, led to a rise in petrol prices across Australia and Asia. Before the war, inflation hawks were already putting pressure on the Reserve Bank of Australia (RBA) to increase interest rates. Now, markets anticipate the RBA to raise rates this Tuesday, followed by another hike in May. But what happens after that is anyone's guess. The prolonged war and sustained global energy price shocks could potentially end Australia's post-COVID experiment of maintaining an unemployment rate below 5%.
Australia's unemployment rate has been remarkably stable, hovering between 3.4% and 4.4% since October 2022. The RBA has been on a mission to gradually reduce inflation while keeping unemployment as low as possible. This strategy is a stark contrast to the pre-COVID era, when the RBA was more aggressive in driving down unemployment. In 2019, when Scott Morrison was Prime Minister, the federal treasurer, Josh Frydenberg, had no plans to push the unemployment rate below 5%. Back then, inflation was struggling to rise above 2%, and wage growth was at record lows. Wasn't an unemployment rate of 5% too high in that context?
The RBA's approach was to keep interest rates at 1.5% for almost three years to boost economic activity. Senior RBA officials encouraged workers to demand pay raises and reminded governments of the benefits of extra infrastructure spending. However, inflation remained tepid. When Frydenberg announced his 2019-20 budget, which aimed to maintain the unemployment rate at 5% for four more years, the RBA lost patience and started cutting rates again. By October 2019, the cash rate was reduced to 0.75%, months before COVID-19 hit Australia.
In early 2021, Treasury officials released a paper acknowledging that their historic estimate of 'full employment' in Australia was likely incorrect. They suggested that the economy could have handled a lower unemployment rate over the previous five years, somewhere between 4.5% and 5%. A few weeks after this revelation, Frydenberg announced his intention to use the upcoming budget to deliberately drive the unemployment rate below 5%.
The RBA's post-COVID inflation-fighting strategy has faced criticism from some economists. They argue that the RBA should have raised rates higher in 2023 and 2024 to effectively eliminate inflation. The fact that inflation started rising again in the second half of 2025 is seen as a problem that could have been avoided. RBA officials have had to defend their position, reminding critics that low unemployment is a positive outcome. However, these arguments are now becoming irrelevant as the world grapples with the impact of the Middle East war on inflation.
The RBA is preparing for another wave of supply-driven inflation, and the question arises: Will they stick to their current strategy or change course? The duration of the war is a critical factor. The RBA's readiness to face another global inflation surge soon after the 2022 crisis raises an important point. In October last year, two IMF economists published a paper suggesting that inflation-targeting central banks did not perform better than non-inflation-targeting banks in the wake of the 2022 inflation surge. They warned that the world is entering a period of sustained and overlapping supply disruptions, challenging the inflation-targeting framework.
They coined the term 'new inflation' to describe this phenomenon, emphasizing that supply-side shocks are becoming more frequent and structurally entrenched due to geopolitical realignments, evolving trade patterns, climate-related disruptions, and the energy transition demands. Central banks now operate in a more complex and uncertain environment, and the inflation-targeting framework may need adaptation. The 2022 experience suggests that front-loaded interest rate hikes do not guarantee improved inflation outcomes, raising questions about the appropriate pace and scale of response.
As the RBA Board announces its next interest rate decision this week, with the cash rate target currently at 3.85%, the future of Australia's unemployment rate hangs in the balance. The anticipation of rising rates has already prompted ANZ Bank to increase its fixed mortgage rates by up to 0.25 percentage points. The RBA's strategy will be put to the test, and the outcome will significantly impact Australia's economic landscape.
