Headwinds build for the Australian economy as energy shock shifts inflation outlook

Commonwealth Bank economists expect inflation to rise further in the near term, driven by higher fuel prices and renewed pressure on global supply chains, while economic growth eases as households and businesses face higher costs and tighter financial conditions. The analysis is based on the oil price at $US120 a barrel to end of June before returning to $US80.

Australia’s economic outlook has shifted materially following a renewed escalation of conflict in the Middle East, they say, with higher energy prices expected to lift inflation, slow growth and push unemployment modestly higher over the next two years

Belinda Allen, Head of Australian Economics at Commonwealth Bank, said the energy shock has complicated an already delicate economic balance.

“Prior to the conflict, the Australian economy was operating above its supply capacity and inflation was proving stubborn. The latest energy shock adds a new layer of complexity, lifting inflation further while also weighing on growth,” she said.

“There is a wide range of possible outcomes from here,” Allen said. “What is clear is that higher energy prices are a headwind for the economy, and both households and policymakers will need to navigate a more challenging environment.”

The updated outlook comes as global institutions also warn the energy shock is likely to keep inflation higher for longer. In a snap update following the Middle East conflict, the Organisation for Economic Co‑operation and Development (OECD) lifted its inflation forecast for Australia in 2026, citing higher oil prices and renewed disruption to global energy markets.

Inflation to rise before easing in 2027

Under CBA’s central oil price scenario, headline inflation is now expected to rise to around 5.4 per cent by mid‑2026; a figure significantly higher than earlier forecasts. Trimmed mean inflation, the Reserve Bank’s preferred underlying measure, is forecast to peak at 3.8 per cent, before easing gradually as economic growth slows and labour market conditions soften.

The most immediate impact is expected to come through fuel prices. Retail petrol and diesel prices have already risen sharply and could increase further in coming months as global oil prices remain elevated.

Beyond fuel, higher energy costs are expected to flow through to a wide range of goods and services, including transport, freight, packaging and food production. Supply chain disruptions linked to shipping routes through the Middle East are also adding to price pressures.

The OECD warned central banks need to remain alert to the risk that higher prices become entrenched. It said inflation expectations are more likely to remain anchored if households and businesses are confident central banks will take action to bring inflation back to target.

While inflation in Australia is expected to remain elevated in the near term, CBA economists expect it to moderate in 2027 as demand slows and unemployment edges higher.

Growth slows as households feel the squeeze

According to CBA analysis, Australia’s economic growth is now expected to ease to around 1.6 per cent by late 2026, down from earlier forecasts. Lower spending by households is expected to be the main factor dragging on growth, as higher prices and interest rates weigh on people’s ‘real income’ purchasing power.

The growth in real household disposable income – that is, the increase in income over and above price inflation, interest payments and tax – is forecast to slow sharply, limiting the capacity for consumers to absorb higher living costs. While households still hold solid financial buffers, such as being ahead on their mortgage payments, spending growth is expected to remain subdued as their confidence in the economic outlook decreases, together with income growth.

Business investment is expected to be more resilient, boosted by tailwinds like data centre investment and renewable energy projects. Even so, higher costs and softer demand are likely to weigh on profitability in some sectors, CBA’s economists say.

Unemployment to rise modestly

As growth slows, the unemployment rate is also expected to drift higher, reaching around 4.6 per cent by early 2027, compared to a seasonally adjusted rate of 4.3 per cent recorded in February. While this represents an increase in the jobless rate, unemployment would still be considered low by historical standards.

CBA economists expect the rise in unemployment will help ease domestic inflation pressures over time, supporting a gradual return towards the Reserve Bank’s target band of between 2 and 3 per cent.

What this means for interest rates

Commonwealth Bank economists say the Reserve Bank is expected to remain focused on containing inflation in the near term and the bank expects the cash rate to be increased again in May, with the decision finely balanced between upside inflation risks and downside risks to growth and employment.

“The RBA is likely to prioritise inflation control in the near term, particularly given the risk that higher energy prices feed into inflation expectations,” Allen said.

Inflation is also on the radar of the OECD, which warned that while higher interest rates can weigh on growth, failing to contain inflation risks prolonging cost‑of‑living pressures. It said while central banks face a difficult balance, allowing inflation expectations to drift higher would ultimately be more damaging for households and the economy.

Looking further ahead, CBA economists said they expected interest rates to be cut in 2027 as inflation moderates and economic conditions soften.

Uncertainty remains high

The outlook remains highly uncertain and will depend heavily on how the conflict evolves and how long energy prices remain high, CBA economists say. In addition to the central scenario of Brent oil hitting $US120 a barrel and staying there till end of June before returning to $US80, they have also considered alternative scenarios, including one where oil prices rise significantly further and another where prices fall back more quickly.

The OECD, meanwhile, cautioned governments against on broad cost‑of‑living support measures in response to energy shocks, warning that untargeted help for consumers could add further to inflation pressures. Instead, it said, any support should be tightly targeted and temporary, to avoid adding to demand at a time when inflation is already high.

You can read the full report here.