Treasury modelling puts inflation at 5% as Chalmers seeks worse scenarios

Jim Chalmers told reporters on 26 March that Treasury's existing inflation scenarios are "pretty conservative now" and that the government has asked for new modelling to account for a worsening Middle East war. The Treasurer said inflation could peak "in the high 4s or even higher," putting the number close to the 5% mark that Treasury's own prolonged conflict scenario already projects.

Treasury released two scenarios earlier this year. The first, a short-term disruption, assumes oil prices hit US$100 a barrel in the first half of 2026 and return to previous levels by year's end. Under that scenario, headline inflation peaks three-quarters of a percentage point higher than the baseline. The second, a prolonged disruption, puts oil at US$120 a barrel and assumes prices take three years to normalise. Headline inflation peaks 1.25 percentage points higher under that model, landing it around 5%.

Inflation already running hot before oil shock

The February 2026 inflation reading came in at 3.7%, still well above the Reserve Bank's 2-3% target band. The RBA raised the cash rate to 4.10% on 17 March in a 5-4 split decision, the narrowest margin for a rate rise in the current cycle. A Treasury assessment released alongside the scenarios put it bluntly: "inflation rises and growth is hit."

"It's a reason to go further, not slower," Treasurer Jim Chalmers said on the case for accelerating economic reform.

Chalmers said the Middle East conflict "will be a defining influence" on the May 12 budget. The prolonged scenario would cut GDP by 0.6% by 2027, and Treasury estimated the war "could cut GDP growth by up to 0.2 percentage points across our major trading partners." Those trading partner losses feed back into Australian export revenue and commodity demand in ways that compound the direct oil price shock, though the precise second-order effects remain the subject of the new modelling Chalmers has commissioned.

Anyone who sat through the early 1990s recession or the drawn-out grind of the 2008 financial crisis will recognise the pattern forming here: an external shock arrives, policymakers initially model moderate scenarios, the moderate scenarios get overtaken by events, and new, grimmer models are requested. The fact that Treasury's own Treasurer is publicly calling the department's published scenarios conservative within weeks of their release is, at minimum, an unusual piece of bureaucratic candour from Canberra.

Fuel reserves and national cabinet

National cabinet met this week to discuss the fuel crisis. The government has released 20% of the national fuel reserve, and Chalmers said Australia currently holds its largest fuel reserves in 15 years. The reserve release is designed to put downward pressure on petrol prices at the bowser, though fuel industry figures in recent weeks have cautioned that reserve drawdowns buy time rather than solve underlying supply constraints if shipping routes through the Middle East remain disrupted.

The 4.10% cash rate already makes this the tightest monetary policy setting since 2008. The RBA's 5-4 split on 17 March suggests at least four board members saw the case for holding steady, even with inflation at 3.7%. If headline inflation moves toward the 5% mark that Treasury's prolonged scenario projects, the board will face a grim choice between further tightening into an oil-driven supply shock and tolerating inflation well above its target band for an extended stretch.

Chalmers has consistently framed the conflict as a reason to push harder on structural economic reform rather than retreat to fiscal caution. "It's a reason to go further, not slower," he said on 26 March. The May 12 budget will be the first full test of whether that framing translates into spending decisions, tax measures, or both.

Treasury's two published scenarios bracket a wide range of outcomes. In the short-term model, oil returns to pre-crisis levels within six months and the inflation bump is manageable at three-quarters of a percentage point above baseline. In the prolonged model, oil stays elevated for three years, inflation hits roughly 5%, and GDP takes a 0.6% hit by 2027. Chalmers is now asking Treasury to model something worse than either of those. The fact that the Treasurer considers a three-year oil shock at US$120 a barrel to be the conservative end of the spectrum tells you where Canberra thinks this conflict is heading.