Rate hikes won’t fix inflation caused by fuel prices

The inflation figures released last week confirm what we already know: Inflation is up, and it’s all because of higher fuel costs.

The March figures confirm that none of the inflation has flowed through to other parts of the economy. An astonishing 90 per cent of the monthly increase was from automotive fuels alone. In fact, if automotive fuels had not increased, annual headline inflation would have been lower than the previous month.

This was confirmed by the Australian Bureau of Statistics measure of underlying inflation, called the trimmed mean. It was unchanged from the previous month at 3.3 per cent. The trimmed mean has now been steady on 3.3 per cent for the past four months.

But why is this important?

It is important because we need to disentangle what is causing the increase in prices. If the price increases are caused by excessive demand, then increasing interest rates can help lower that kind of inflation.

But if the increase in prices is caused by a supply shock, then interest rates are ineffective at lowering inflation.

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