RBA deputy warns of 'central banker's nightmare' as energy shock lifts stagflation risk

Australia faces a testing period as a global energy shock raises the risk of stagflation, Reserve Bank of Australia deputy governor Andrew Hauser has warned, calling the combination of high inflation and weak growth a "central banker's nightmare".

Speaking at a Money Marketeers of New York University event in New York, Hauser said the war in the Middle East was likely to deliver a "big income shock" to Australia and push inflation higher. He added there was not much the central bank could do to stop prices rising in the short term.

The "big question", he said, is how the current energy shock and the coming wave of inflation will affect economic activity in Australia and how those forces will feed into inflation over the next two to three years. Stagflation occurs when economic activity stagnates while prices keep climbing, a damaging mix that can be accompanied by rising unemployment and recession.

"The stagflationary shock: inflation up, activity down. Judging the balance between those two is, I guess, how we earn our money," Hauser said. He noted consumer confidence in Australia has already declined significantly, a shift that could weigh on activity this year.

Headline inflation is 3.7 per cent, above the RBA's goal of keeping inflation averaging between 2 and 3 per cent. Hauser said inflation was already too high before the war broke out, and that the RBA did not have "high confidence" that interest rates are at the right level yet.

Hauser said the central bank is monitoring developments closely as economists in Australia warn about the possibility of stagflation amid the global energy shock. The coming months, he cautioned, will be challenging as policymakers navigate the trade-offs between taming inflation and supporting growth.