OECD Economic Outlook, Volume 2026 Issue 1

Australia

The Australian economy had considerable momentum on the eve of the evolving Middle East conflict but now faces headwinds that will hinder growth and push up inflation this year. GDP growth is projected to slow slightly to 1.9% in 2026 and 1.8% in 2027. The energy price spike will push headline inflation above 4% this year, but its unwinding should help inflation fall back to about 2½ per cent in 2027. The main risks are that the energy supply shock is larger than expected or that the policy reaction triggers a sharper-than-projected slowdown in demand growth.

Monetary policy tightening, already underway pre-conflict, may need to be continued but should be unwound as inflation subsides. Limited temporary fiscal measures to mitigate dislocation from the energy supply shock may be warranted, but revenue windfalls from high commodity prices should be mostly saved. To enhance energy security and boost sustainable growth, Australia should accelerate progress with electric vehicle adoption and renewables generation, with improved grid links and increased storage capacity.

Pre-conflict macroeconomic developments were mostly favourable

Before the onset of the Middle East conflict, the economy was enjoying a period of strengthening growth and healthy labour market conditions. Year-on-year GDP growth in the fourth quarter of 2025 reached 2.6%, above estimated potential, while the pre-conflict unemployment rate was low and stable. Inflation, which had picked up in the third quarter of 2025, stabilised from October onward and showed initial signs of returning to the 2-3% target range.

Australia

Source: OECD Economic Outlook 119 database; and U.S. Energy Information Administration (EIA).

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Australia: Demand, output and prices

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The most immediate impact of the conflict on the economy was via fuel prices. By mid-April, diesel prices had risen by some 66% and petrol prices by 59%, notwithstanding a temporary federal excise tax cut which cut retail prices by about 10%, although prices subsequently fell back somewhat. The conflict’s impact has also been seen in business and consumer confidence measures, which fell sharply. In addition, financial conditions have tightened, with 10-year government bond yields surging to over 5.1%, their highest level since 2011, before settling near 5%.

Monetary policy tightening is likely and fiscal policy is expected to tighten mildly

With pre-conflict headline inflation already above target and the Reserve Bank of Australia in a tightening phase, further policy rate increases are likely as inflation is pushed higher by the energy supply shock. One additional rate increase is expected by September 2026, before an easing phase begins in 2027 as inflation subsides and labour market slack emerges. Existing fiscal plans at the federal and state/territory levels imply consolidation through 2027. The energy shock is not expected to have a major net impact on general government budget outcomes, with revenue windfalls from higher-than-expected commodity prices roughly offsetting the negative effect of lower activity and the modest energy price relief measures announced to date. The general government deficit is expected to decline this year and next, with a rise in the debt-to-GDP ratio through end-2027.

Economic conditions should improve in 2027 as headwinds reverse

The adverse demand impact of the energy supply shock and the monetary policy response to it will weigh on GDP growth this year, although this should give way to a rebound through 2027 as those headwinds reverse. The slowdown mainly reflects weaker consumption growth, as higher inflation and mortgage rates erode real disposable incomes. Job growth will also ebb, pushing the unemployment rate up by about half a percentage point by end-2026. Headline inflation, which was 3.7% in February, will jump to around 5% in the coming months as the impact of higher fuel costs is felt. The projected reversal of the energy price spike means that its inflationary effects should be dissipating from the second half of 2026 onward, although the surge in fertiliser prices could push up food prices in 2027. Core inflation will remain above the mid-point of the 2-3% target range throughout 2026-27 but should be within the range and approaching the mid-point by late 2027. Apart from the risk of a more serious disruption of oil and gas production and shipping from the Middle East than assumed in the projections, Australia-specific risks include the possibility that the impact of monetary policy tightening on consumption and other interest-rate-sensitive spending is greater than projected. At the same time, if second-round price effects are larger than projected, this could imply even higher policy rates in 2026 and later or no easing in 2027, with negative growth implications in both years.

Coping with the energy supply shock and delivering reforms

Monetary policy should only be further tightened if inflation expectations become unanchored, threatening a prolonged inflationary episode despite the growth slowdown. Conditional on expectations remaining anchored, an easing of policy may be needed as economic slack gathers. Given the relatively large general government deficit and rising public debt ratio, steady medium-term consolidation in line with Australia’s fiscal framework will be needed. Any revenue windfalls arising from the conflict should be mostly saved, while limited temporary measures to help affected sectors deal with the impact of the energy price spike may be justified. Australia’s vulnerability to fuel supply disruptions underlines the case for accelerating progress with electric vehicle adoption and renewables generation, with improved grid links and increased storage capacity. Other needed policies, such as easing restrictive land-use regulation, especially in urban areas, could also help to curb fuel consumption and improve energy security, while at the same time boosting productivity growth and addressing affordability challenges.