The Reserve Bank raised interest rates this afternoon. The more important question isn’t why, it’s whether the problem they’re trying to solve is one that interest rates can actually fix. By the close of trading on 16 March, the ASX 30-day interbank futures curve was already pricing a higher path for the cash rate through late 2026 and into 2027. In other words, today’s decision didn’t emerge in a vacuum. Markets had already begun positioning for it.

Because the inflation pressure building in the system right now doesn’t look like a traditional demand boom. It looks much more like a supply shock moving through global energy and food systems.

The System

At its simplest level, inflation reflects an imbalance between supply and demand. Demand can be too strong, supply can be too weak, or both can occur simultaneously.

When inflation is driven primarily by excessive demand, monetary policy is a reasonably effective tool. Higher interest rates reduce borrowing capacity, slow spending and eventually bring prices back into balance.

But when inflation originates from supply disruptions, the mechanism becomes much less straightforward.

Roughly twenty per cent of the world’s oil and fertiliser trade passes through the Strait of Hormuz. When geopolitical tension rises around that corridor, the consequences ripple quickly through the global economy. Energy prices rise first. Transport costs follow. Fertiliser prices rise, and food prices eventually follow.

Those pressures are not caused by excessive household borrowing or a booming domestic economy. They originate from a physical constraint in global supply chains.

Which leads to a fairly obvious question.

How exactly does raising interest rates reopen shipping lanes or repair oil refineries?

Monetary policy is powerful, but it does have limits.

Raising the cash rate can slow credit growth, cool property markets, and reduce discretionary spending.

It is less effective at reopening the Strait of Hormuz.

Higher interest rates can slow demand elsewhere in the economy while the original supply shock continues to move through the system.

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When the Metric Becomes the Target

Economists sometimes describe this dynamic using Goodhart’s Law: when a measure becomes the target, it stops being a good measure.

Central banks target CPI inflation, but CPI is a downstream gauge. It captures price increases once they appear in consumer goods and services. It does not capture the earlier stages where inflation pressures often begin, particularly in commodities, production inputs or asset markets.

Over the past decade, a significant portion of global monetary expansion appeared first in asset prices. Property, equities, and financial assets absorbed much of that pressure long before it began to appear in consumer goods.

By the time inflation becomes clearly visible in CPI, the forces that created it have often already passed through the system.

In other words, the inflation gauge is sometimes positioned on the wrong part of the machine.

The Lag in the System

Monetary policy also operates with long delays. Interest rate changes typically take twelve to eighteen months to fully work their way through the economy. Supply shocks, by contrast, can appear extremely quickly.

Energy markets can reprice in days. Shipping disruptions can emerge overnight. Geopolitical tensions can reshape commodity markets within weeks.

This mismatch creates an unusual situation in which central banks are responding to inflation reflecting conditions from months earlier, while the economic environment may already be changing.

Policy ends up steering the economy using a rear-view mirror.

The Historical Pattern

None of this means central banks are behaving irrationally. They are operating within a framework designed to manage demand-driven inflation.

But history shows that supply shocks often behave differently.

The oil crises of the 1970s, the Gulf War in 1990, the energy surge following the Russia–Ukraine conflict, and several other commodity disruptions all generated inflationary pressures that monetary policy could not directly resolve. Higher interest rates slowed economic activity, but the underlying adjustment occurred in the physical economy.

Production expanded.
Supply chains adapted.
Energy markets eventually stabilised.

The solution ultimately came from the supply side rather than monetary policy.

The Pattern Behind the Pattern

Modern monetary policy tends to treat inflation as a domestic demand problem. When prices rise, the assumption is that households are spending too much and that tightening credit will eventually restore balance.

But the global economy does not operate as a closed system. Energy, fertiliser, shipping and commodities form the upstream layers of production, and shocks in those layers propagate outward through the rest of the economy.

When those upstream systems tighten, prices can rise even while domestic demand is already slowing.

That is the uncomfortable scenario policymakers sometimes face. The inflation signal comes through CPI, but the cause lies elsewhere in the production chain.

This is why periods of supply-driven inflation often produce the most difficult policy decisions. The tools available are designed to suppress demand, while the disturbance originates in supply.

The Asset Inflation Blind Spot

There is another complication that has become increasingly visible over the past decade.

Inflation does not always appear first in consumer prices. It often appears first in asset markets.

Property markets.
Equity markets.
Financial assets.

Those markets tend to respond quickly to monetary expansion and to changes in credit conditions. By the time inflation spills over into consumer prices, a large part of the adjustment may already have occurred in asset values.

This creates a delayed feedback loop. Asset inflation builds for years without triggering a policy response because CPI remains contained. When inflation finally appears in consumer prices, policy tightens after the asset cycle has already peaked.

From a systems perspective, it can appear that the inflation gauge is located downstream of where the pressure first emerges.

The Economic Trade-Off

The risk in the current environment is that the economy absorbs two shocks at once.

The first shock comes from rising energy and food prices.

The second shock comes from higher borrowing costs.

Both reduce household purchasing power.

Recent spending data already suggests households are cutting discretionary expenditure as mortgage payments and living costs rise. If energy prices continue climbing while interest rates remain elevated, the combined effect could slow the economy more quickly than policymakers expect.

This is why some economists are beginning to warn of the possibility of a stagflationary environment, with slower growth alongside persistent inflation pressures.

Central banks are also trying to prevent second-order effects, where supply-driven inflation feeds into wages and expectations. The difficulty is doing that without tightening into an already slowing economy.

The Housing Channel

For property markets, the transmission mechanism remains straightforward.

Housing prices are constrained by borrowing capacity. Interest rates determine how much households can borrow, and that borrowing capacity sets the ceiling for housing prices.

When interest rates rise, borrowing capacity falls.

That does not eliminate the structural housing shortage in Australia, but it does reduce buyers’ ability to express demand in the market. This is particularly true in the current housing landscape, where prices have continued to rise at around twice the pace of wage increases for many decades.

In past cycles, the final years of a boom were always characterised by house prices rising as interest rates rose. What is the same this time is that we are at the final stages of the boom years, and interest rates are indeed rising again.

What is different is that house prices and wages have diverged so much that demand cannot be evenly distributed across the market, leading to a sector rotation towards smaller, more affordable dwellings.

The shortage may still exist, but the credit conditions that allow buyers to participate in the market can tighten.

The Bigger Question

Monetary policy was designed to manage demand. It was never designed to repair supply shocks.

Energy markets will eventually rebalance as production adjusts and supply chains respond. Shipping routes reopen, fertiliser supply increases and price pressures ease.

Interest rates cannot accelerate that process.

They can only influence the level of economic activity during the adjustment. That tension sits at the centre of today’s decision.

The RBA has responded to inflation as its framework dictates. The open question is whether the inflation pressure currently emerging in the system is something monetary policy can meaningfully solve.

And that may turn out to be the more important question, not just for this cycle, but for how monetary policy responds to the next one.