Hormuz has reached the mortgage market — could Australia be next?

A tanker is attacked in the Middle East.

Oil becomes harder and more expensive to move.

The price of crude rises.

Diesel, petrol and aviation fuel become more expensive.

Businesses face higher transport and input costs.

Inflation rises.

And eventually, a household thousands of kilometres from the Strait of Hormuz can find itself paying more interest on its mortgage.

That chain of events is no longer theoretical.

On Thursday, the European Central Bank raised its key interest rate by 25 basis points to 2.5 per cent as it attempts to prevent the energy-price shock generated by the Iran war from spreading more deeply through the European economy.

At almost exactly the same time, Brent crude surged more than 6 per cent to settle at US$107.63 a barrel.

For Australia, the lesson deserves attention.

The Reserve Bank of Australia cannot reopen the Strait of Hormuz.

It cannot repair a damaged tanker.

It cannot protect Saudi oil infrastructure.

And it cannot produce another barrel of Middle Eastern crude.

But if the consequences of those events produce persistent inflation in Australia, the RBA may eventually have to respond to them.

That is the uncomfortable connection between a war in the Persian Gulf and an Australian mortgage.

Europe has demonstrated the mechanism

The European Central Bank's decision is significant because it shows what can happen when an external energy shock persists long enough to become a domestic inflation problem.

The ECB lifted its key rate from 2.25 per cent to 2.5 per cent.

It has also increased its inflation forecasts.

Eurozone inflation moved above 3 per cent during the northern summer and the ECB now expects inflation to average 2.5 per cent in 2027, compared with its previous forecast of 2.3 per cent.

The central bank is particularly concerned that expensive energy could eventually push up the prices of other goods and services.

That is the crucial point.

Central banks can tolerate temporary fluctuations in energy prices.

A sudden increase in oil that quickly reverses does not necessarily require higher interest rates.

The problem arises when the shock persists.

Businesses begin paying more for transport.

Manufacturers pay more for energy and materials.

Airlines pay more for fuel.

Farmers pay more for diesel and fertiliser.

Retailers pay more to move products.

Employees encounter higher living costs and may seek higher wages.

Eventually an external energy shock can become embedded in the domestic price structure.

At that point the central bank has a problem.

Interest rates cannot produce oil

There is a fundamental limitation to monetary policy that becomes particularly obvious during an energy crisis.

Higher interest rates do not produce energy.

An ECB rate rise will not persuade a tanker captain to enter Hormuz.

It will not increase Saudi oil production.

It will not reduce war-risk insurance premiums.

It will not restore damaged infrastructure.

It will not create another LNG cargo.

What higher interest rates can do is suppress demand elsewhere in the economy.

Consumers borrow less.

Businesses invest less.

Housing activity can slow.

Households with mortgages have less disposable income.

The central bank effectively attempts to prevent an externally generated price shock from spreading by restraining the parts of the economy it can influence.

It is a blunt instrument.

But central banks have few alternatives when persistent inflation threatens their price-stability mandates.

A central bank cannot create the missing barrel of oil. It can only make the rest of the economy compete less aggressively for what remains.

Oil above US$107

The European decision has arrived as the energy situation deteriorates again.

Brent crude settled on Thursday at US$107.63 a barrel, up US$6.42 in a single session.

West Texas Intermediate rose to US$102.48.

Both benchmarks reached their highest levels since May.

The immediate trigger was another escalation in attacks affecting shipping and Middle Eastern energy infrastructure.

Traffic through the Strait of Hormuz remains severely constrained.

Iran and the United States have attacked tankers.

Merchant vessels have been damaged.

A seafarer has been killed.

Saudi energy facilities have come under attack.

Houthi forces have seized the Yemeni port of Mocha, adding another potential source of risk around Red Sea shipping.

The market is therefore no longer pricing a hypothetical threat that Iran might one day disrupt Hormuz.

It is pricing a disrupted energy system.

OPEC cannot simply turn on another tap

Another development demonstrates the physical nature of the problem.

OPEC oil production fell by approximately 640,000 barrels a day in August to 19.71 million barrels a day.

That happened despite several OPEC+ producers previously agreeing to increase production.

The reason is revealing.

Saudi exports were disrupted by the war, while the American blockade reduced Iranian shipments.

In other words, there is an important difference between deciding to produce more oil and being able to get that oil into the international market.

A production quota is an economic decision.

A functioning pipeline, export terminal, tanker route and insurance market are physical requirements.

The present crisis is interfering with those requirements.

Australia is not Europe

None of this means the Reserve Bank of Australia is about to copy the ECB.

Australia and Europe have different economies, different energy systems and different inflation dynamics.

The RBA will make its own decisions using Australian data.

That distinction is important.

But the RBA has already identified the Middle East conflict as an inflationary influence.

In its August Statement on Monetary Policy, the Bank said the conflict had disrupted oil and LNG production and shipping and contributed to elevated global energy prices.

It also found evidence that conflict-related input costs had already contributed to Australian underlying inflation, including through new dwelling costs and, to a lesser extent, groceries.

At that stage, however, Brent crude was around US$80 a barrel.

It is now above US$107.

That does not automatically translate proportionately into Australian inflation.

But it materially changes the risk.

Australia's particular vulnerability

Australia is an enormous energy producer.

That fact can create a misleading sense of security.

Australia exports LNG and coal and produces crude oil.

But Australian motorists and businesses participate in an international petroleum market.

Much of the petrol, diesel and aviation fuel consumed here is imported as refined product or influenced by Asian refined-fuel benchmarks.

Those prices respond to crude availability, refinery capacity, shipping costs, insurance, inventories and competition between buyers.

The RBA has previously noted that Asian refined petroleum products constitute the majority of Australia's fuel imports.

That means disruption thousands of kilometres away can eventually appear on an Australian service-station price board.

And diesel deserves particular attention.

Diesel is not merely a household motoring expense.

It powers trucks.

It powers farms.

It powers mines.

It powers construction equipment.

It helps move food from producers to supermarkets and manufactured products from ports and warehouses to businesses.

Higher diesel prices therefore have the capacity to move through the economy.

The second-round problem

Central banks distinguish between the immediate effect of an energy shock and what economists call second-round effects.

The first-round effect is obvious.

Petrol becomes more expensive.

The consumer price index rises.

But if petrol later becomes cheaper, much of that direct inflationary impulse can disappear.

Second-round effects are more troublesome.

A transport company increases its charges because diesel is expensive.

A supermarket pays more for distribution.

A builder pays more for transported materials.

An airline raises fares.

Employees seek compensation for higher living costs.

Businesses increase prices to protect margins.

The original oil shock has then begun reproducing itself elsewhere in the economy.

That is what central banks fear.

It helps explain why the ECB has acted even though European interest rates have no influence over military decisions in the Persian Gulf.

The RBA's dilemma

If Australia's inflation continues moderating despite expensive oil, the RBA may be able to look through some of the temporary energy effect.

If the Hormuz crisis eases and Brent retreats, the problem could diminish quickly.

But there is another possibility.

The conflict persists.

Oil remains above US$100.

Shipping and insurance remain expensive.

Diesel and petrol remain elevated.

Businesses progressively pass those costs through.

Inflation expectations rise.

Then the RBA faces the same fundamental dilemma now confronting Europe.

It can accept higher inflation and hope the external shock eventually disappears.

Or it can restrain Australian demand to reduce the probability that temporary imported inflation becomes persistent domestic inflation.

Neither option is painless.

From Hormuz to the household

This is why Australians should pay attention to developments in the Strait even if they never buy a barrel of Middle Eastern crude.

The economic transmission mechanism is surprisingly short.

Hormuz affects the availability and cost of oil.

Oil affects refined fuel.

Fuel affects transport and production.

Those costs affect inflation.

Inflation influences central banks.

Central banks influence interest rates.

Interest rates influence mortgages.

The consequences of a maritime conflict therefore do not stop at the shoreline.

They can eventually reach the household budget.

The Times View

The European Central Bank has demonstrated something Australians should understand.

An energy war does not have to occur within a country's borders to influence its interest rates.

The ECB cannot end the Iran war. It cannot reopen Hormuz or manufacture cheap oil.

Yet it has raised borrowing costs because it fears the economic consequences of expensive energy becoming entrenched.

Australia is not necessarily heading for the same outcome.

But we are exposed to the same fundamental mechanism.

The Reserve Bank cannot control the price of oil, the behaviour of Iran, the decisions of tanker owners or the cost of maritime war insurance.

It can only respond to the consequences when they arrive in the Australian economy.

That exposes an uncomfortable limitation of monetary policy.

A central bank cannot create the missing barrel of oil. It can only make the rest of the economy compete less aggressively for what remains.

For an Australian household, that distinction can seem academic until the international energy shock contributes to another interest-rate decision.

Then the distance between Hormuz and home suddenly becomes very small.