New modelling warns oil tipped for $120 as Middle East conflict rages on
Treasury has warned that inflation could surge to 5% this year if the war with Iran continues apace, although a softening labour market may have blunted the odds of this doomsday scenario.
New modelling released by Treasurer Jim Chalmers (pictured) on Thursday sketches a prolonged Middle East conflict that drives oil to US$120 a barrel and keeps it elevated for years, pushing headline inflation to at least 5% and leaving GDP still below its pre‑war trajectory by 2029.
While this is a doomsday scenario – other modelling anticipates oil prices to stay at $100 per barrel, causing inflation to peak closer to the 4.5% mark – all possibilities are on the table as the Iran war drags on.
Around half the damage to growth comes directly from higher energy costs, with the rest flowing from broader disruptions to supply and confidence.
In comments due to be made in Melbourne on Thursday, Chalmers conceded that government spending has been part of the inflation story (a hard thing to ignore, given the Reserve Bank of Australia (RBA) factored it into its decision to raise rates on Tuesday) and is now teasing “substantial savings” in the May Budget.
The opposition has long called on Labor to rein in public spending.
As shadow treasurer Tim Wilson said this week: "What we need is a treasurer who's going to take responsibility, control spending and make sure that he's not actively stoking an inflation agenda, as he is right now, because Australians are paying it through $27,600 a year more on the average mortgage.”
It is likely that the opposition will get its wish. With outlays sitting at near four‑decade highs outside the pandemic, the government is reportedly mulling cuts to public services, including the NDIS, defence and childcare subsidies.
While Chalmers contended that "a lot of progress" has been made on budget sustainability, he conceded that more must be done.
Unemployment ticks higher
Today’s higher-than-expected February unemployment data may have taken the edge of Labor’s worst-case inflation scenario, if only slightly.
The labour market showed signs of cooling in February, as the seasonally adjusted unemployment rate rose to 4.3% in February 2026, exceeding both the 4.1% forecast and levels seen in the previous two months. The number of unemployed increased by 35,000 to a three-month high of 659,100 from 624,200 in January.
The RBA watches unemployment as a key disinflation signal, but will likely need clearer evidence of labour market softening before it shifts cash rate policy.
ANZ analysts believe softening may be in store, if only slightly.
“Looking ahead, we expect labour market conditions to ease over 2026,” said ANZ economist Aaron Luk and ANZ head of Australian economics Adam Boyton in a Thursday research note.
Monetary tightening “should weigh on demand and growth and gradually loosen labour market conditions”, they said, although “given the degree of momentum in the economy, any increase in the unemployment rate is likely to be modest”.
With the Australian three-year bond yield still running hot at 4.6%, it’s clear that the market still expects one if not two more rate increases before the year ends.
It is clear that, just as the Iran war has already gone for longer than US president Donald Trump had anticipated, Australia's own war with inflation may only be starting.
