We held a positive outlook on the Australian macro earlier this year, but that view has been substantially undermined by the war in Iran. Surging fuel prices, rising interest rates, and the flow-on effects to cost-of-living pressures are now the dominant themes shaping the domestic economy. Growth forecasts have been marked down to 1.3% year-over-year from 2.2% pre-war, while inflation expectations have pushed up to 3.9% from 3.0%. The global supply shock has knocked the RBA off its preferred strategy of walking a benign “narrow path” that preserves gains in the labour market, and the Monetary Policy Board now appears willing to tolerate a rougher return to the inflation target, one that features weaker growth and employment. We now expect the RBA to raise the cash rate by 25 basis points in both May and June, taking the terminal rate to 4.60%. The probability of a recession over the next 12 months has risen to around 25%.
Research published 16 April 2026. Analysis based on institutional research available at time of writing.
The Household Squeeze Is Real
In contrast to the optimism of just a few months ago, households and businesses are facing a genuinely challenging environment on multiple fronts. Financial conditions have become a material headwind and we expect higher inflation and interest rates to weigh meaningfully on real household disposable incomes, with growth of just 0.6% year-over-year expected by end-2026. Nominal house prices are forecast to decline around 3.1% year-over-year by the first quarter of 2027, which removes another source of wealth effect support for consumer spending.
The Federal Budget next month may deliver some incremental and targeted cost-of-living support, but the broader tailwind to growth from the public sector continues to fade. Public sector contribution to GDP growth has been declining steadily since its post-COVID peak, and the Budget is unlikely to reverse that trend in any meaningful way.
A recession in the next 12 months still remains far from the base case. But the risk has risen from its unconditional average of around 11% to a 25% subjective probability, which is higher than what probit regression models alone would suggest. That tells you the range of plausible scenarios has widened considerably.
Inflation Is Uncomfortably High and Getting Worse Before It Gets Better
The first quarter 2026 CPI report is expected to show headline inflation of 4.4% year-over-year and trimmed mean of 3.6%. Looking further ahead, and even accounting for the temporary halving of the fuel excise, higher fuel prices are expected to push headline inflation to 4.9% year-over-year in the second quarter, which we expect to mark the cyclical peak.
Encouragingly, our favoured trend measure of inflation expectations remains anchored so far. But the potential for second-round effects from the fuel price shock is clearly in focus. Indirect first-round effects are already showing up in surging wholesale fertiliser prices, and there has been a marked pick-up in price increases across building supply companies. Reece and TradeLink, two of the major plumbing and trade supply distributors, have both been announcing price increases at an elevated pace, which feeds directly into construction costs and ultimately into housing inflation.
The Oil Shock and the Risk of Fuel Rationing
The oil shock so far has mostly been a story of higher prices rather than outright shortages. Domestic fuel inventories have remained relatively stable at around a month’s worth of consumption, and the government’s fuel diplomacy push, which has included agreements with Singapore, Malaysia, Brunei, Japan, South Korea, and Indonesia, has helped shore up supply.
However, real concerns remain about whether fuel, and particularly diesel, can be secured at any cost should trade disruptions from the war persist. Those concerns intensified this week following a fire at one of Australia’s only two oil refineries, which could temporarily suspend up to 10% of domestic fuel supply.
In a fuel rationing scenario, the government would likely manage demand through purchase limits, mandatory work-from-home rules, and discouragement of corporate travel. We estimate the direct GDP headwind from WFH mandates (via reduced fuel consumption) and corporate travel limits at around 20 basis points and 10 basis points respectively. For producers, fuel rationing would see the government prioritise supply to essential services like healthcare, utilities, transport, and emergency services, with limits imposed on industries that are highly fuel-intensive but contribute relatively low gross value add and are less integrated in the broader supply chain.
The industries most vulnerable in a fuel shortage are those with both high diesel intensity and deep supply-chain integration. Road transport sits at the top of that list, followed by forestry and logging, sawmill manufacturing, and cement manufacturing. Mining operations, particularly coal and iron ore, are large consumers of diesel but sit lower on the supply-chain integration scale, meaning they could absorb rationing with less cascading disruption.
What This Means for the RBA
Setting aside the fuel rationing tail risk, the RBA’s fundamental policy stance has evolved in a clearly hawkish direction. The earlier focus on finding a “narrow path” that balances returning inflation to target while preserving labour market gains has given way to something rougher. Governor Bullock recently commented that “we don’t want to have a recession, but if it’s hard to get inflation down, then you know we’re going to have to deal with that possibly.” The March RBA Minutes explicitly welcomed the prospect of slower growth as helping the Monetary Policy Board achieve its objectives sooner.
We view the RBA as now having a higher tolerance for weaker growth and employment, and an intention to engineer exactly that.
A key factor in our updated forecast is the RBA’s evolving reassessment of financial conditions. Governor Bullock recently hesitated to characterise financial conditions as restrictive, and the March Minutes flagged that the cash rate sits within the range of model-based estimates of the neutral rate. RBA Deputy Governor Hauser observed this week that “we’ve been on the easy side of that stance.” In other words, the RBA believes policy may not yet be restrictive enough, even at 4.10%.
Our best guess is that the RBA views the current rate as roughly neutral and that 50 basis points of further tightening is needed to feel confident that policy is clearly restrictive. We lean toward back-to-back 25 basis point hikes in May and June rather than a more gradual approach spread over three meetings. Front-loading allows the RBA to argue it has taken decisive action before the inflation data deteriorates further into July.
We view financial conditions as already meaningfully restrictive and expect that hard data on growth and employment will eventually catch lower towards the weaker signals from recent business and consumer confidence surveys, which have deteriorated sharply since the war began.
Further ahead, we forecast rate normalisation beginning in the first half of 2027, with the terminal rate coming back down to 3.60% against a backdrop of much weaker growth and inflation.
The Outlook Is Unusually Uncertain
The macro outlook right now is genuinely uncertain in a way that makes scenario analysis more important than point forecasts. There are feasible scenarios where the RBA tightens back-to-back through May, June, and August, but also scenarios where they pause and hold from here.
The key risk centres on the duration of the war in Iran and the related disruption to global oil supply. Prediction markets currently assign around a 93% probability that the conflict will end within a month. If that holds, it would reduce upside risks to oil prices and inflation while also lowering the probability of a global recession. A more protracted conflict, on the other hand, increases the risk of outright stagflation.
Domestically, the key upside risks to inflation come from May’s Federal Budget being more stimulatory than expected and from a potential acceleration in wages growth should the Fair Work Commission agree to a real wage increase in FY2027. On the downside, inflation risks could ease if there is a sharp sell-off in asset prices that unexpectedly tightens financial conditions, or if severe fuel security issues spill over into growth more than currently anticipated.
Taking all of these risks into account, probability-weighted forecasts for the cash rate are slightly more hawkish than market pricing in the near term but materially more dovish over the longer run. The market appears to be underpricing how far and how fast the RBA will move in the next two months, but overpricing how long those elevated rates will persist.
New Zealand Is a Different Story
Across the Tasman, the RBNZ Governor pivoted hawkish at last week’s meeting, flagging a scenario where “decisive and timely increases in the OCR would be required.” But the underlying conditions in New Zealand are fundamentally different. The economy is operating with significant spare capacity, with a negative output gap of around 1.5% of GDP and unemployment tracking about 100 basis points above NAIRU.
There is a high degree of spare capacity in New Zealand, and that is not the kind of environment where a central bank would want to aggressively tighten policy, particularly given the risk of a protracted medium-term inflation undershoot. We view the hawkish language as partly an effort to jawbone inflation expectations lower rather than a genuine effort to set up rate hikes any time soon. Current market pricing for three rate hikes by end-2026 and a further three by end-2027 looks quite unlikely given the weak GDP data and sub-potential growth tracking in the Kiwi-GDP Nowcast.
What We Are Watching
The critical data points over the coming weeks are the 1Q2026 CPI print on 29 April, the May Federal Budget, and any developments in the Iran conflict and Strait of Hormuz situation. The CPI print will largely determine whether the RBA moves in May or waits, and the Budget will shape the medium-term fiscal outlook. Meanwhile, every week the conflict continues adds cumulative pressure to fuel prices and inflation expectations. If the ceasefire holds and the conflict winds down as prediction markets suggest, many of the more extreme scenarios discussed here become much less likely, and the RBA’s path back to normal becomes considerably smoother.
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