Australia would be pushed to the brink of recession and inflation would surge past 7% if the oil crisis sparked by the Middle East conflict dramatically worsened, according to new Treasury modelling released in the federal budget 2026.
Economic Impact of the Middle East War
The budget papers reveal the scale of the economic damage that the US and Israel's war on Iran has already caused Australia and the rest of the world – and how much worse it could get. Treasurer Jim Chalmers stated, "War in the Middle East has been pushing up prices, pushing down growth, and punishing Australians," during his budget speech on Tuesday night.
The federal government now expects inflation to peak at about 5% in the June quarter as the closure of the Strait of Hormuz continues to wreak havoc on global fuel supplies. This forecast is based on an assumption that the global oil price remains around US$100 a barrel until the end of next month before falling to US$80 a barrel by the end of the year.
Worst-Case Scenario Modelling
However, Treasury has also modelled a more "severe" scenario in which oil prices peak as high as $200 a barrel in the September quarter and don't fall to $80 a barrel until mid-2029. In this case, inflation would reach 7.25% in the year through to December – a shock comparable to the end of the Covid pandemic, when price growth peaked at 7.9%. Unemployment would also increase to 5%.
The economy would shrink in the September quarter under Treasury's worst-case scenario, but Chalmers said Australia would avoid a recession. He described the assessment that Australia would escape two consecutive quarters of negative growth as a "forecast rather than an undertaking," conceding the economy was "hostage to developments" overseas.
Global and Domestic Repercussions
The International Monetary Fund has warned that a further escalation of the US-Israel war with Iran could trigger a worldwide recession. The budget papers show that global growth is expected to slow to 3% in 2026, down from 3.5% in 2025.
"As Australians, we confront these serious challenges together and from a position of strength," Chalmers said. "We are much better placed and better prepared than most countries to deal with this global crisis." A 32.8% surge in fuel prices after the outbreak of the war was a major factor in the headline inflation rate rising to 4.6% in the 12 months to March 2026. The budget papers also indicate that prices are expected to rise in other areas over coming months, including food and housing construction.
Budget Measures in Response
While the government stayed committed to property investor tax reforms despite the global uncertainty, the Middle East conflict forced significant changes to Chalmers' budget plans. The budget sets aside $11.9 billion over five years for a suite of previously announced measures to shore up fuel supplies, including funding to help increase the nation's reserves to a 50-day supply. The decision to halve the fuel excise and pause the heavy vehicle road user charge for three months will cost the budget $2.9 billion.
As expected, the budget did not include a new tax on gas exports after Anthony Albanese shelved the idea to avoid antagonising key Asian trading partners – South Korea, Japan and Singapore – that Australia relies on for petrol and diesel supplies. The government has been under mounting pressure to impose a 25% tax on gas export revenue in place of the petroleum resource rent tax (PRRT), which critics argue extracts too little revenue from gas giants.
Receipts from the PRRT have been revised up $1.6 billion over the five years from 2025-2026 as a result of higher oil prices from the war. Revenue from the 40% profits tax is expected to reach $1.9 billion in 2026-27 before declining in each of the following three years, undermining the gas industry's argument that it will increase over time.
"We didn't decide when this war began and have no control over when it will properly end," Chalmers said, in what sounded like a thinly veiled reference to US President Donald Trump's unpredictability. "But how we respond is up to us."
