Australia’s Treasury modelled two Iran conflict scenarios: oil staying at $100 per barrel for H1, or rising to $120 and taking three years to return to pre-conflict prices. Updated figures, compared with modelling from a week earlier, indicate an extra 0.25 percentage point added to headline inflation and a doubling of the negative effect on GDP.
Under the short-term scenario, headline inflation is estimated to peak 0.75 percentage points higher. Output is projected to be 0.2% lower around the middle of this year.
Under the prolonged scenario, headline inflation is estimated to peak 1.25 percentage points higher. GDP is projected to be 0.6% lower in 2027 and still below the no-conflict path in 2029.
About half of the GDP effect is linked to higher oil prices, with the rest tied to wider economic consequences. At the time of writing, AUD/USD was up 0.22% at 0.7120.
Looking back at the Treasury modelling from early 2025, the prospect of inflation peaking in the high 4s is now our present reality. The latest figures for the December 2025 quarter showed headline inflation at 4.3%, making the Reserve Bank of Australia’s position increasingly difficult. This persistence suggests interest rate derivatives should be positioned for a hawkish hold from the central bank, with a non-trivial risk of a further rate hike this year.
The short-term scenario, which we saw modelled with oil at $100, is effectively in play as Brent crude now trades near $98 a barrel amid ongoing Middle East tensions. This has kept volatility in energy markets extremely high, with the Crude Oil Volatility Index (OVX) sitting at a 12-month peak. Traders should consider strategies that benefit from this volatility, such as buying straddles on oil futures to profit from a large price move in either direction.
The negative impact on GDP, which was then estimated to be around 0.2% lower, is now being reflected in forward-looking indicators. We are seeing this pressure in recent business confidence surveys, which fell to a two-year low in February 2026. This environment warrants caution, favoring strategies that are short domestic-focused cyclical stocks and long commodity exporters who benefit from the elevated prices.
While higher oil prices would typically support the Australian dollar, the broader global risk aversion has capped any significant rally. The AUD/USD, which was trading at 0.7120 when these concerns were first modelled in 2025, is now struggling to hold the 0.6750 level against a stronger US dollar. Options traders should note that one-month implied volatility for the pair has risen to over 11%, indicating expectations of larger price swings in the weeks ahead.
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