Australia Unemployment: Will Middle East Conflict Kill Low-Rate Experiment?

The question of whether Australia is poised to abandon its recent run of low unemployment is gaining urgency, fueled by escalating geopolitical tensions in the Middle East and the resulting shockwaves through global energy markets. The International Energy Agency (IEA) has reported the largest supply disruption in the history of the global oil market according to its latest report, triggering a surge in crude oil, gas, and fertilizer prices. This price escalation is already being felt in Australia and across Asia, with petrol prices climbing sharply.

Prior to the outbreak of the current conflict, the Reserve Bank of Australia (RBA) was already facing mounting pressure from inflation hawks advocating for interest rate increases. Now, market expectations point towards a rate hike this Tuesday, followed by another in May. The trajectory beyond that remains uncertain, but a prolonged war in the Middle East, coupled with sustained high energy prices, could effectively finish Australia’s post-COVID experiment with an unemployment rate consistently below 5 percent.

A Shift in Strategy: From Full Employment to Inflation Control

In recent years, Australia’s unemployment rate has fluctuated between 3.4 percent and 4.4 percent since October 2022, a period of historically low joblessness. The RBA has been attempting to navigate a delicate balance: bringing inflation down gradually while preserving as much employment as possible. This approach represents a significant departure from pre-COVID economic policy.

In 2019, under then-Prime Minister Scott Morrison and Treasurer Josh Frydenberg, the ambition wasn’t to drive unemployment below 5 percent. The 2019-20 budget forecasts, as shown in Budget Paper No.1, reflected this stance. At that time, inflation was struggling to surpass 2 percent, and wage growth was stagnant. The RBA responded by maintaining interest rates at a historically low 1.5 percent for nearly three years, encouraging businesses to invest and workers to seek wage increases.

However, the RBA grew impatient with the unhurried progress on inflation and began cutting rates again in late 2019, ultimately reaching 0.75 percent by October – months before the arrival of COVID-19 in Australia.

Revisiting the Definition of “Full Employment”

The COVID-19 pandemic prompted a reassessment of Australia’s economic assumptions. In early 2021, Treasury officials released a paper suggesting that their previous estimate of “full employment” – the level of unemployment consistent with stable inflation – was too high. They posited that Australia’s economy could have sustained unemployment rates between 4.5 and 5 percent without triggering inflationary pressures.

Shortly after, Treasurer Frydenberg announced a deliberate strategy to drive unemployment below 5 percent, marking a significant shift in economic policy. This change in approach laid the groundwork for the RBA’s subsequent efforts to balance inflation and employment.

The Post-Pandemic Inflation Challenge

The outbreak of the Russia-Ukraine war in 2022 unleashed a new wave of global inflation. The RBA responded by aggressively raising interest rates, but notably, it refrained from tightening monetary policy as aggressively as some other countries. The RBA prioritized avoiding a recession and aimed to bring inflation down gradually while preserving employment. This strategy has drawn criticism from some economists who argue that a more forceful approach would have been more effective in curbing inflation.

As noted in a speech by Sarah Hunter, assistant governor (economic) at the RBA, the RBA’s approach is illustrated in this comparison of interest rates with other countries.

The “New Inflation” and the Limits of Traditional Policy

Recent research from the International Monetary Fund (IMF) raises questions about the effectiveness of traditional inflation-targeting strategies in the current economic environment. A paper published in October 2025 found that central banks focused on inflation targeting did not outperform those that did not during the 2022 surge. The IMF economists argued that inflation-targeting frameworks are better suited to managing demand-driven shocks than supply-driven ones.

They warned that the world is entering an era of frequent and persistent supply disruptions, driven by geopolitical realignments, evolving trade patterns, climate change, and the energy transition – a phenomenon they termed “new inflation.” This suggests that the RBA’s current approach may face increasing challenges in the face of ongoing supply-side shocks.

The RBA Board will announce its next interest rate decision this Tuesday afternoon, with the cash rate currently at 3.85 percent. ANZ Bank has already preemptively increased its fixed mortgage rates, anticipating a rate hike. The central bank’s decision will be closely watched as it navigates the complex interplay between inflation, unemployment, and global economic uncertainty.

The unfolding situation in the Middle East adds another layer of complexity. The duration of the conflict and its impact on global energy prices will be critical factors in determining the RBA’s future policy decisions. The question remains whether Australia can sustain its experiment with low unemployment in the face of these mounting challenges.