Andrew Hauser, the Reserve Bank of Australia’s deputy governor, says the “stagflationary shock” from the Iran war is a “central banker’s nightmare”, as confidence among Australian households crashed to its lowest level in years.

Speaking at an event in New York on Tuesday morning AEST, Hauser said the RBA was “judging the balance” between the damage to the economy from “a big income shock” associated with soaring fuel prices, versus a sharp rise in inflation.

“It is the central bankers’ nightmare: the stagflationary shock, with inflation up, [economic] activity down – judging the balance between those two,” he said.

Climbing consumer prices are typically associated with a strengthening economy, but stagflation is when inflation is rising at the same time as growth is weakening and unemployment climbing.

It presents central bankers with a dilemma as interest rate moves to address one of the two economic problems can make the other worse.

The most extreme version of stagflation was during the 1970s oil shocks, when the jobless rate and inflation both hit double figures, although the circumstances are very different today.

Hauser’s comments came hours before Westpac’s monthly survey revealed spiking fuel costs and higher interest rates had triggered the sharpest drop in consumer confidence since the Covid pandemic.

Matthew Hassan, a senior economist at Westpac, said Australians “are being hit by another cost of living shock” as the twin blow of more expensive mortgages and higher pump prices are “again putting finances under intense pressure”.

The confidence index collapsed by 13% to 80 points and back to near all-time lows experienced during the initial onset of Covid and the early 1990s recessionary period.

“A sharp deterioration in expectations suggests consumers are bracing for a return to the extended period of weakness seen during the 2022–24 inflation fight,” Hassan said.

The survey was conducted after the federal government announced a temporary 26 cent cut to the fuel excise.

Ahead of the Westpac report, Hauser noted that consumer confidence measures had “fallen very, very sharply”.

“I don’t think those surveys necessarily tell you a lot about what consumption is going to do. But if they’re right, we have a big income shock coming our way.”

He noted that Australia was “the highest user of diesel per capita in the world”.

“So this is a big real income shock for Australia, even if national income and fiscal coffers may benefit from that net export position.”

With unleaded petrol prices up 30-40% in March, and closer to 80% for diesel, economists at the CBA predict that inflation will jump by nearly 1 percentage point to 4.6% in the year to March

That would be nearly double the RBA’s official 2.5% target.

Financial markets early Tuesday morning priced in a 64% chance of a third straight interest rate hike at the next RBA boarding meeting on 5 May, and Hauser said it was “easy to see that upside inflation pressure”.

But the deputy governor flagged while inflation was already “too high” leading into the Middle East conflict, the central bank needed to look beyond just the initial impact on prices, saying it was “more important for us now to think through what that medium term impact might be”.

“It might still be on the upside, in which case we’re going to have to respond [with higher rates],” he said.

“But we do also need to take account of the possibility that activity slows.”