Treasurer Jim Chalmers is being warned not to use the budget to deliver cost-of-living handouts to deal with the inflation fuelled by the Iran war, with the International Monetary Fund fearful the globe could be pushed into a recession if hostilities do not end soon.
As the Reserve Bank’s deputy governor said central banks were facing an economic “nightmare” as surging oil prices hit shoppers and businesses, the IMF overnight said the war had upturned the world’s economy and increased inflation pressures that could take years to overcome.
While the Australian economy is this year expected to be one of the world’s strongest, it is also forecast to have some of the highest inflation, which would be exacerbated if Chalmers uses the budget on May 12 to go on a spending spree without offsetting handouts with spending cuts.
The IMF has downgraded its outlook for the global economy, expecting it to expand by 3.1 per cent this year. That would be a drop from 2025 and well short of the 3.7 per cent average between 2000 and 2019.
If not for the war, the international fund said it would have upgraded its outlook but the combination of a crunch on the supply of key exports out of the Middle East and the associated lift in inflation will hurt world economic activity.
Such is the uncertainty over the outlook, the IMF cautioned that its forecasts were predicated on a quick resolution to the war. If the war continues, growth could slow to just 2 per cent, which would be the first global recession since the pandemic, while inflation would climb beyond 6 per cent.
Australia’s economy is tipped to grow by 2 per cent this year which, among rich nations, would be the third fastest in the world behind the United States and Spain. But Australia’s inflation, at 3.9 per cent, would be among the highest and sit alongside nations such as Russia (5.6 per cent) and Brazil (4 per cent).
Nations at the heart of the war are dealing with terrible economic consequences. Iranians face an inflation rate of 69 per cent this year after 50 per cent in 2025, while the economies of the United Arab Emirates, Qatar, Iraq and Bahrain are all expected to contract in 2026.
At least 60 countries, including Ireland and Japan, have introduced cost-of-living relief to deal with the spike in fuel prices. The Albanese government has halved fuel excise for three months, shaving 32 cents a litre off petrol prices at a cost of $2.5 billion to the federal budget.
But IMF chief economist Pierre-Olivier Gourinchas, who urged central banks to remain “vigilant” against any inflation breakout, said spending sprees would only add to their inflation problems.
“Where fiscal support is deemed to be necessary to protect the most vulnerable against extreme external shocks, it should be targeted, timely, temporary and funded within current budget envelopes by reprioritising spending, and if that is not possible, with the path to restore fiscal balances clearly communicated,” he said.
“To replenish buffers for future shocks, governments should … mobilise revenues, reprioritise expenditures, make spending more efficient and manage windfalls prudently.”
Chalmers, who will attend the IMF’s meetings in Washington this week and will hold bilateral meetings with fellow treasurers from South Korea, Japan, China, Britain, Indonesia and Singapore, said the fund’s forecasts highlighted the dangerous moment facing the global economy.
He said the cost of the war in the Middle East would weigh on the domestic and global economy for some time with the issue central to next month’s budget.
“The world is expecting slower growth, higher inflation, and extreme volatility arising out of the conflict in the Middle East, and we are too,” Chalmers said.
“We’re weighing all of this extreme uncertainty as we prepare a budget focused on resilience and reform.”
Data released on Tuesday showed business and consumer confidence nose-diving because of the war.
NAB’s closely watched measure of business conditions and Westpac’s similarly important tracker of consumer sentiment both showed confidence falling to its lowest level since the depths of the pandemic.
According to NAB, business confidence fell by 29 points in March, although trading conditions only eased a single point.
Westpac’s measure dropped by almost 13 points in April, with consumers particularly worried about their current finances, while 80 per cent expect interest rates to climb over the coming 12 months.
About 40 per cent think rates could climb by a full percentage point. If that eventuated, monthly repayments on a $600,000 mortgage would climb by $400.
Shadow treasurer Tim Wilson said the fall in confidence was an indictment of the government’s economic management.
“This collapse in consumer and business confidence is not abstract, they are a verdict on the Albanese government’s active inflation agenda, and preparation to withstand international events,” he said.
At a conference in New York, RBA deputy governor Andrew Hauser noted the collapse in consumer confidence and also the inflationary impact of soaring oil prices.
“We’re the highest user of diesel per capita in the world. So this is a big real income shock for Australia, even if national income and fiscal coffers may benefit from that export position,” he said.
“I think if you put that all together, it’s obvious that inflation is going up in the short term, and people are very conscious of that.
“Consumer confidence indices have fallen. I don’t think those surveys necessarily tell you a lot about what consumption is going to do, but if they’re right, we have a big income shock coming our way. It is a central banker’s nightmare.”
Markets took Hauser’s comments as confirmation the Reserve would consider a third consecutive interest rate hike at its meeting in May. The Australian dollar, which early on Monday fell below US70¢, rose beyond the US71¢ mark on expectations that interest rates may push higher.
The RBA’s meeting is being held the week before Chalmers hands down the budget.
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Shane Wright is a senior economics correspondent for The Age and The Sydney Morning Herald.Connect via X or email.