The expanding conflict in the Middle East presents Australia with a genuine economic dilemma that transcends the usual political divides.Treasurer Jim Chalmers has warned price hikes in Australia are a likely outcome of economic uncertainty linked to war in the Middle East. The challenge for policymakers lies not in whether costs will rise, but in how severe the impact becomes and how long it persists.
The most immediate threat is at the service station pump.If only Iranian production is disrupted, oil could rise to around US$100 per barrel; if the Strait of Hormuz is affected for up to a month, Brent prices could spike to US$113; but a three-month disruption could see oil rise to US$185, scenarios that could hike petrol prices by between $0.25 to $1.00 per litre, dependent on movements in the Australian dollar and refinery margins.
What complicates Australia's fiscal picture is that higher fuel costs do not stop at the bowser.Oil is the starting ingredient for petrol, diesel and jet fuel, and when its price rises, it can push up transport costs, which can gradually make many everyday things more expensive, even for people who never visit a service station. This matters significantly for households already stretched by cost-of-living pressures.
Treasurer Chalmers noted there will be an increase in fuel prices, but if war drags on, there will be a decrease in supply of goods such as fertiliser, which will potentially have flow-on impacts. Agricultural inputs like fertiliser depend on energy-intensive production, and their scarcity would feed directly into food prices. Australia's vulnerability here deserves serious attention.Australia exports 70 per cent of its food production while facing significant domestic food insecurity.
The Reserve Bank's response will prove critical.RBA governor Michele Bullock says the escalating conflict could exacerbate inflation although the overall impact remains unclear, noting it is too early to say what the impact will be as events are moving rapidly and there are different ways this can play out. Her cautious language reflects a genuine policy bind:Westpac said a one-month disruption to supply from the Strait of Hormuz would lift Australia's Consumer Price Index by around one percentage point, with GDP growth about 0.2 percentage points lower.
Yet the relationship between oil and interest rates is not straightforward.If oil hits US$100 per barrel, interest rates could settle around 0.25 percentage points higher over the longer term; if it rises to US$150 per barrel, the higher inflation effect on spending could allow the RBA to leave rates on hold. This reflects a tension embedded in monetary policy: temporary supply shocks can drive up headline inflation without necessarily requiring rate rises, while sustained price increases risk becoming embedded in wage and pricing expectations.
The geopolitical dimension adds another layer of uncertainty.Russia and China have increasingly acted as Iran's "eyes" by providing high-tech strategic assets that range from orbital surveillance to advanced missile guidance. However, their commitment has limits.Officials from Russia and China have condemned the U.S.-led strikes but stopped short of pledging military or civilian support to Tehran.While Iran has increasingly turned towards China and Russia, analysts do not expect either to provide significant defence or security support.
For Australian policymakers, the challenge is to distinguish between temporary price movements and sustained inflationary pressure. A sharp but brief spike in oil costs presents a manageable problem for the RBA, which can "look through" headline inflation and maintain patient monetary policy. But if the Middle East conflict persists for months, the calculus changes fundamentally. Transport costs become entrenched; food prices climb as fertiliser supply tightens; consumer confidence erodes as uncertainty lengthens.
What is often overlooked in discussing these scenarios is the interaction between energy costs and fiscal policy.The government is forecast to spend $37 billion more than it raises this financial year, spending that makes a big contribution to an economy running too hot. An energy shock arriving on top of an already stretched budget creates compounding pressures. The government's hand in responding to fuel price surges is limited by its own fiscal position.
The evidence suggests reasonable caution rather than alarm.Over the past six months, oil has mostly been around the mid US$60s, well below the spikes above US$100 seen in 2022. Australian policymakers have managed energy shocks before. What distinguishes the current moment is that inflation was already within the RBA's danger zone, household balance sheets are stretched, and there is no fiscal buffer for price relief measures. A brief disruption Australia can absorb. A prolonged conflict would test both institutional capacity and social patience in ways that demand serious contingency planning.