Get ready for a budget slowdown. But Chalmers insists we won’t see a recession
- Written by John Hawkins, Head, Canberra School of Government, University of Canberra
Treasurer Jim Chalmers has called his budget “ambitious in the face of adversity”.
Speaking to reporters in the lockup on Tuesday, he acknowledged his latest budget is “not exactly the same budget we would have handed down in February for obvious reasons”.
The main adversity is a Middle East war that has disrupted around a fifth of global seaborne oil and gas supply. It has also hit global supply chains for fertiliser, chemicals, aluminium and plastics. Treasury assumes the global economy will slow from 3.5% growth in 2025 to 3% in 2026.
A slowing economy
As a consequence, the Australian economy is forecast to suffer a similar slowdown, with inflation rising more quickly than previously forecast.
The updated Treasury forecasts in the federal budget envisage growth in the Australian economy will slow from 2.25% growth in 2025-26 to a modest 1.75% next year.
Australia’s exports are forecast to barely grow at all – just 1%. Adding to the gloom for exporters, the prices of our key commodity exports – iron ore, coal, LNG and gold – are assumed to decline from what Treasury calls elevated levels.
Business investment and housing construction are also both projected to slow in 2026-27. Supply chain disruptions due to the war pose a risk of weaker business investment, because most capital equipment is imported.
The government is optimistic employers will respond to the economic slowdown by cutting hours, rather than laying off workers. The unemployment rate is expected to rise only slightly, from 4.3% to 4.5%, remaining well below pre-pandemic levels.
A surge in prices
In last year’s budget, Treasury was expecting a benign inflation outlook. The forecast was for consumer prices to rise by 3% in 2025-26 and then 2.5% in the next three years. This would be comfortably in the middle of the Reserve Bank’s 2-3% target range.
But the inflation outlook has deteriorated markedly with the war in the Middle East driving up the prices of petrol, fertilisers and plastics.
This year’s budget predicts inflation will peak at 5% this financial year before returning to around the midpoint of the Reserve Bank’s target range in the following years.
This is similar to the Reserve Bank’s latest forecast, which has inflation peaking at 4.8% this quarter. The central bank also forecasts inflation to drop back into the target range as the oil price drops.
Cost of living stress continues
High inflation and rising interest rates from the Reserve Bank will lead households to tighten their belts. Wages growth, at only 3.25%, is predicted to lag well behind the 5% growth in prices this year, putting more strain on household budgets. On a more positive note, the moderation in wages will help keep the unemployment rate low.
In subsequent years, wages growth is forecast at 3.5%, above the forecast 2.5% inflation, allowing households to gradually restore their living standards.
It could be worse
The Treasury forecasts assume the Middle East conflict eases and allows global oil prices to fall from mid-2026 (that is, very soon).
The budget papers also include alternative scenarios. In the pessimistic scenario, an escalation in the conflict drives oil prices up to about double the current level of US$100. Although growth would slow further, Chalmers says even under the severe scenario, we would still avoid a recession.
Under this scenario, inflation peaks at over 7% and the unemployment rate hits 5%. This would pose an even more challenging question for the Reserve Bank, which may feel it needs to increase interest rates even further to maintain the credibility of their 2-3% inflation target.
More red ink
The budget continues to project deficits, equivalent to 1% of GDP, for four years. Further out, the gap between spending and revenue gradually narrows until the budget is back in balance around 2034-35. If the economy is weaker than Treasury is forecasting, however, these deficits will be even larger.
Continuing deficits translate into increasing government debt. But a growing economy means that debt relative to GDP peaks in 2028-29.
That’s on current estimates. But as the Treasurer pointed out, events in the Middle East may have an outsized impact. We’re hostage to developments in lots of ways.
Key details
Authors: John Hawkins, Head, Canberra School of Government, University of Canberra
