The Reserve Bank of Australia does not want to send the country into a recession but its options to avoid one might be running out.
Governor Michele Bullock has told reporters a recession could be a possibility if inflation proves too hard to get down, after the central bank hiked interest rates for a second straight month.
The RBA still hoped to tame inflation without tanking the economy and causing an unnecessarily large spike in unemployment, she said.
"We don't want to have a recession. But if it's hard to get inflation down, then you know, we're going to have to deal with that possibly," Ms Bullock said.
Inflation has been rising in Australia because demand is greater than supply. In central bank jargon, the economy has a positive output gap.
The RBA still thinks it can bring that positive output gap down to zero, without taking it negative, Bullock said.
She believes the bank can lower inflation by gradually taking the heat out of the economy without sending it into a tailspin.
"That's been the approach all along and she was clear in saying that's still the approach," National Australia Bank chief economist Sally Auld told NAB's Morning Call podcast on Wednesday.
"But I guess she did open the door just a crack to a scenario where they might not be successful in that strategy.
"Which is to say that if you really want to nail inflation then you can only do that successfully by imposing a greater cost on macroeconomic outcomes."
With war in the Middle East driving up oil prices and exacerbating inflation pressures, HSBC chief economist Paul Bloxham warned an economic downturn was needed to properly get inflation under control.
Whether that requires a recession or just a slowdown in growth depends on how long the RBA can tolerate high inflation, he said.
"The risk is that inflation expectations now start to become unanchored, and that people start to believe that inflation won't actually get back to 2.5%," Bloxham told AAP.
Bullock acknowledged this, saying it was critical that inflation expectations stayed anchored.
Already, the bank will be concerned by high-frequency data released by ANZ and Roy Morgan.
Inflation expectations lifted 0.6 percentage points to 6.7% in their latest consumer confidence survey, released on Tuesday.
That's the highest level in more than three years.
Treasurer Jim Chalmers pushed back at fears of a recession, saying it was neither the RBA's nor Treasury's base case forecast.
"We need to be careful not to put words in [Bullock's] mouth," he told Nine's Today Show programme.
"She was saying in a world where we don't get on top of inflation, and in an uncertain global environment, things are very unpredictable."
How resolute the RBA is in getting on top of inflation quickly will determine whether the board delivers a third successive rate hike in May.
As will events in the Middle East.
If the conflict drags on and oil prices climb high enough, a global economic slowdown could fight the RBA's inflation battle for it, Bloxham said.
"The global financial crisis, effectively, was the recession 'we had to have'," he said.
"It's possible that the global economy could deliver a disinflation at this point too, but we don't know.
"So with that as a sort of known unknown, then the RBA obviously has to take action themselves."
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