Central Banks Fight Oil With Rate Hikes They Know Won't Work

The Reserve Bank of India is contemplating a repo rate hike to 5.50 percent. The Bank of Canada's Governor Tiff Macklem has signaled further increases ahead. The Reserve Bank of Australia maintains steady pressure for additional tightening. All three are responding to the same culprit: oil prices that have climbed above $100 per barrel, a threshold that transforms commodity markets into central bank puppet masters.

This is monetary policy theater, and the audience is starting to notice the stagehands.

India's inflation problem, Canada's 3 percent rate, and Australia's 4.0 percent August reading share a common origin that rate hikes cannot solve. These are not demand-side inflations that respond predictably to borrowing costs. These are supply-side shocks arriving from OPEC production decisions and geopolitical tensions that no amount of tighter monetary policy can address. Yet central banks across three continents are hiking anyway, constrained by inflation mandates that treat all price increases as equivalent regardless of origin.

The logic is straightforward and entirely backwards. Oil above $100 per barrel filters through transportation costs, energy bills, and petrochemical inputs. Inflation data picks this up. Central bank governors see inflation above target. Central bank governors raise rates. This is what the script demands.

What the script omits is the mechanism. Higher borrowing costs do not increase oil supply. They do not convince OPEC to open the taps. What they do accomplish is reduce demand across an economy already struggling with stagflationary pressures—slower growth combined with persistent price increases. The RBI raising the repo rate to 5.50 percent will cool Indian business investment and household consumption. It will not reduce the price of crude by a single dollar barrel.

Julian Howard, chief multi-asset investment strategist at GAM Investments, has already warned that rate-setters are on the verge of policy mistake territory. The diagnosis is correct. The treatment is the problem.

Canada offers the clearest case study. Inflation sitting at 3 percent triggers rate hike signals from Governor Macklem. Strip out the energy component and the underlying inflation picture is far less alarming. Yet central banks operate with blunt instruments and binary choices. They see inflation above target. They raise rates. Nuance is for research papers that policymakers read after the damage is done.

Australia's 4.0 percent August inflation reading similarly reflects global commodity dynamics rather than domestic demand pressures. The RBA's maintenance of rate hike pressure appears almost mechanical—the central banking equivalent of touching a hot stove to confirm it remains hot. Each time oil prices spike, the response is predetermined. Each time the response fails to meaningfully address the underlying shock, the next meeting yields further tightening as if the previous increase simply wasn't tight enough.

The uncomfortable truth that Isabel Schnabel, ECB board member, has articulated is that central banks cannot wait for inflation to arrive before acting. This sounds prudent. It becomes dangerous when applied to supply shocks. If output reduction succeeds in pushing global prices higher, as Schnabel warns, central banks might find themselves forced to adopt a more hawkish approach to fight the very inflation they created through demand destruction. The policy feedback loop becomes vicious—not virtuous.

OPEC has effectively captured central bank policy across the developed world. When Saudi Arabia decides production, it is not consulting with Delhi, Ottawa, or Sydney. Yet these central banks are reacting as though they possess the ability to offset these decisions through monetary tightening. They do not. What they possess is the ability to slow their own economies in pursuit of an inflation target that includes components entirely outside their control.

Brent crude jumped 3 percent to top $100 per barrel as of October 1, with analysts expecting WTI oil prices to range between $82.50 and $97.50 per barrel for October amid elevated volatility from geopolitical tensions. This volatility will persist regardless of what the RBI, Bank of Canada, or RBA decide about rates. But the policy response will continue anyway, because central banks have become prisoners of inflation data and commodity markets have become their jailers.

The curtain on monetary policy theater is indeed getting very thin. The audience can now see the stagehands.