Budget reveals Australia could be on verge of being hit by nightmare scenario

The billions of dollars spent on cushioning Australia from the worst impacts of the fuel crisis may not be enough to shield the country from the economic firestorm of a protracted conflict in the Middle East, the government has warned in tonight's federal budget.

Large swathes of the budget papers were dedicated to touting the government's response to the global oil shock triggered by Israel and US President Donald Trump's war on Iran, including securing one billion litres in extra petrol and diesel and a $7.5 billion investment in local supply and storage.

But the government is still hanging its hopes on global oil prices declining by mid-way through the year, and stabilisation by the same time in 2027.

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In case the war in the Middle East is prolonged or escalates, Treasury modelled a "severe" scenario in which oil prices would peak at $US200 per barrel by September and take three years to calm down.

And if Trump's latest remarks – in which he claimed the fragile ceasefire with Iran is hanging on by a thread and is on "massive life support" – are anything to go by, there is a risk it could be edging closer to reality.

Under the grim scenario, Australian household budgets and businesses would suffer further as inflation drives up the cost of living.

"This could occur if the conflict is protracted or if an escalation further damages energy and export infrastructure across the Middle East and shuts off oil supply from the region, including through the Red Sea trade route," the budget papers state.

"The scenario assumes there are corresponding price increases for related commodities, including (natural gas), fertiliser and petrochemicals. Global risk premia are also expected to be higher, and household and business confidence are expected to be lower."

In this case, it would take until June 2029 for oil prices to eventually recede to $US80 per barrel.

Treasurer Jim Chalmers warned Australia's economy would take a nosedive if this scenario unfolds – although says a recession wouldn't come to pass.

"We would still avoid a recession, but unemployment would spike to pre-pandemic levels and inflation would peak above 7 per cent," he said.

"As Australians, we confront these serious challenges together from a position of strength.

"We know there's more work to do because the immediate costs and consequences of this war are already serious and could be severe."

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Though a recession would indeed by narrowly avoided, the government predicted that it would result in one quarter of negative growth and "persistent weakness" in the economy.

Inflation would peak at 7.25 per cent this December and it would take two quarters longer to return to the Reserve Bank's target range of 2-3 per cent, compared to current forecasts. Inflation is currently at 4.6 per cent.

Unemployment would also hit five per cent in 2027-28 for the first time since the pandemic and take years to decline to 4.5 per cent in early 2030.

But in a best-case scenario, Treasury forecasts inflation to peak about five per cent by the middle of this year.

"For the same reasons, it's expecting growth to come in half a percentage point lower next financial year, to be 1.075 per cent overall," Chalmers added.

However the treasurer did offer some words of encouragement after the budget's "severe" scenario modelling detailed every Australian's worst nightmare.

He told the nation that Australia can emerge from this global crisis "stronger, fairer, more productive and more resilient" than before.

"We didn't decide when this war began and have no control over when it will properly end," Chalmers told Australians during his budget speech.

"But how we respond is up to us."

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Iran War's massive impact on budget

This year's federal budget was influenced in large part by the impact of the war in the Middle East, a conflict that has triggered severe economic uncertainty and drastically driven up inflation around the globe.

Six key budget initiatives in 2026 are a response to the global oil shock, with $14.8 billion diverted to a fuel resilience package.

This includes a $3.2 billion fuel reserve, $1 billion in interest-free loans for manufacturing and logistics businesses, the $2.9 billion cost of halving the fuel excise and reducing the heavy vehicle road user charge for three months, and a 20 per cent gas export reserve.

There will also be a $55 million investment in a pilot program known as the Transport Resilience and Capacity Kickstart, which aims to incentivise greater volumes of local ship and rail freight.

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Electrifying Australia's car fleets

There will be an expected 25 per cent fringe benefits tax (FBT) discount for drivers who have bought an electric car which costs over $75,000 by April 2027.

All electric car owners will be able to claim the FBT discount by April 2029.

Up until now, your car needed to cost less than $75,000 to be eligible for this tax break incentive.

Despite a years-long debate over an EV road user charge, there is no mention of it in the 2026 budget papers.

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