A prolonged or intensified conflict in the Middle East could have substantial economic repercussions for Australia, according to Treasury forecasts outlined in recent budget papers. In a severe scenario where war damages energy and export infrastructure or leads to a shutdown of oil supplies from the region, global oil prices could spike to as high as US$200 per barrel by late 2026. This increase is expected to persist for several years, with prices not predicted to fall back to around US$80 per barrel until mid-2029.

The budget papers warn that such a situation would lead to inflation surging to 7.25 percent by the end of 2026, accompanied by unemployment rising to 5 percent in the 2026-27 period. Gross domestic product (GDP) growth could contract by 0.6 percent during this time. The Treasury highlights the potential for both households and businesses to experience significant pressure, with real incomes declining amid rising costs, intensifying cost-of-living challenges. The labour market is also expected to weaken as slower economic activity affects job prospects.

For businesses, higher prices for diesel, fertiliser, and other petrochemical products would increase production costs and could threaten the viability of some firms. This would likely further exacerbate domestic inflationary pressures. However, sectors linked to Australia's status as a net energy exporter, such as liquefied natural gas (LNG) and thermal coal, might see some economic benefits from elevated global commodity prices.

Treasury forecasts also indicate that inflation could peak at a more moderate 5 percent by mid-2026 due to the conflict, with economic growth slowing to 1.75 percent in the following financial year. Treasurer Dr Jim Chalmers described the US$200 oil price projection as “a more severe scenario,” but said Australia would likely avoid a recession. He acknowledged that Australians are already facing increased costs related to the conflict, especially at petrol pumps and beyond.

Dr Chalmers also noted that this economic challenge comes amid what he described as the fifth economic shock in less than two decades, with the Middle East conflict and the closure of the Strait of Hormuz disrupting the global economy and outlook. Despite these pressures, he argued Australia is approaching the crisis from a position of relative strength, citing stronger growth than many peer nations, rising real incomes, low unemployment, and one of the world’s strongest budgets.

The budget documents further point out that inflationary pressures in Australia predate the Middle East conflict. Factors such as the cessation of government electricity rebates and persistent inflation in services contributed to inflation rising above the Reserve Bank of Australia’s target band in 2025. This aligns with recent comments from Reserve Bank governor Michele Bullock, who criticized government spending for sustaining demand above supply, thus stoking inflation prior to the onset of the conflict.

Overall, Australia's economy faces considerable challenges if the Middle East situation worsens and oil markets remain disrupted, but officials maintain that the country is relatively well-positioned to manage the potential impact.