The Reserve Bank has signalled it will continue raising interest rates as the war in the Middle East drives up oil prices and heightens economic uncertainty. Assistant governor Christopher Kent said the conflict could lift the 'neutral' interest rate, the level needed to keep inflation stable, meaning borrowing costs may have to rise further to contain price pressures.

Recent inflation data showed price growth easing slightly in February, but economists expect inflation to climb above five per cent by mid year as higher fuel costs flow through the economy. Financial markets are anticipating at least two more rate increases following recent moves by governor Michele Bullock.

Dr Kent warned that while global turmoil has tightened financial conditions, the supply shock from rising energy prices risks pushing up inflation expectations at a time when Australia is already facing capacity constraints. He stressed that although higher rates and an energy shock could weaken economic activity, the central bank must act to prevent temporary price spikes from becoming entrenched.

The federal Treasury is also modelling the potential economic fallout of prolonged high oil prices, with scenarios based on crude oil reaching one hundred to one hundred and twenty dollars a barrel. Officials cautioned that a longer conflict would increase the risk of deeper economic damage and further market instability.