Oil shocks expose the limits of monetary policy

This report analyses recent changes in Australia’s oil demand and supply, the impact of oil shocks on Australia’s inflation, how those are addressed through traditional monetary tools, and the tools that could be added to Australia’s price stability toolkit to build more resilience to oil price shocks.

Australia has become highly exposed to oil shocks

Since 2000, Australia shifted from being mostly self-reliant for oil products to mostly import-reliant. In FY2024-25, Australia imported the vast majority of its three key oil products: diesel (90%), jet fuel (80%) and petrol (68%). During this period, the country’s use of diesel and jet fuel increased materially, multiplying by 2.5 and 1.8 times respectively. Australia’s diesel use growth is at odds with other countries. It is now the world’s largest importer of diesel, representing 10% of net global seaborne trade. Australia is also the third-largest importer of jet fuel and petrol, representing 8.3% and 6.7% of global seaborne trade respectively. This is well above the country’s share of global GDP.

Scale of Australian oil product imports

Australia imports 96% of its refined oil products from Asia, which is highly reliant on Middle East oil. Our two largest suppliers, representing half of our supply, source about 70% of their crude oil from the Middle East. Global trade of diesel, petrol and jet fuel is also dominated by Asia and the Middle East. As such, Australia has become highly vulnerable to any supply disruptions in the Gulf region. This is exacerbated by Australia’s relatively low oil stockpiles compared with similar countries.

Oil shocks have a large impact on inflation

Since 2000, oil prices have become highly volatile, in part due to frequent geopolitical tensions as well as the low price elasticity of oil demand. In that period, oil prices increased by about 6.9% a year, and oil costs by about 8.9% a year, well above the annual Consumer Price Index (CPI) increase of 2.8%. The growth was not linear, with many oil shocks driven by a combination of supply- and demand-side factors.

This century there have been six main occasions when inflation exceeded the Reserve Bank of Australia (RBA)’s target of 2–3%, with oil price shocks a primary driver for each. Oil affects inflation in three ways. It has a direct impact through household transport expenditure, which contributed a one percentage point increase to the CPI in March 2026. It has an indirect impact by increasing the cost of goods and services: oil accounts for 2–2.5% of domestic costs, and could account for more through global supply-chain costs. Oil prices also have an outsized contribution to inflation expectations, which has flow-on effects.

Contribution of oil price shocks to spikes in Australian inflation

Traditional monetary policies have limitations

The RBA typically uses three main tools to maintain price stability: inflation targeting, increasing interest rates and forward guidance. In the case of oil price shocks, central banks focus on countering spillover impacts of high oil prices on broad-based inflation, using a graduated set of responses depending on the likely magnitude of the spillover. For small shocks, they may “look through” the event; for severe shocks with a high chance of unanchoring inflation expectations, they will take forceful monetary policy action. The RBA mentioned the risk of second-round effects from oil price increases as part of its decision to increase the cash rate by 0.25% in May 2026. In the case of an initial supply-side shock (as is the case with the Iran conflict), a forceful response can have high economic costs, potentially leading to a recession. 

Given the increasing volatility of oil prices, and its recurrent impact on world economies, some central bankers in Europe are calling for a reduced reliance on fossil fuels to protect price and economic stability. However, monetary action to constrain the spillover of oil price shocks makes it harder and more costly to transition to the very technologies that can protect the economy from the impacts of future oil price shocks.

Technologies are now available to shift away from oil, and Australia doesn’t need to remain at the mercy of global oil markets. It now has the option to sever its exposure to oil price shocks — and the inflation that follows. But it needs to add new tools to its price stability toolkit to do so.