IMF delivers a blunt warning to Treasurer Jim Chalmers.

Global outlook darkened by Middle East conflict

The International Monetary Fund has cut its global growth forecast and said rising energy costs tied to the war with Iran are the main culprit. The fund now expects world growth of about 3.1% in 2026, down from earlier forecasts, and says inflation will be higher than it had previously assumed.

It matters because even a small rise in inflation can prompt central banks to raise interest rates.

Pierre-Olivier Gourinchas, IMF chief economist, put it plainly: "the world economy faces another difficult test." He warned that the temporary closing of the Strait of Hormuz and damage to energy infrastructure in the region risk pushing oil and gas prices much higher if hostilities continue. The IMF's baseline assumes energy shocks ease and prices fall back, but the fund also modelled harsher scenarios where prolonged disruption would force central banks to lift rates and could drag global growth well below 3%.

The modelling is stark: in a severe scenario where energy shocks persist and policy tightens, global growth could slump to around 2% in 2026 and 2027 — a level consistent with a global recession.

Fuel prices, inflation and policy crossroads

Higher fuel costs hit households immediately, forcing up petrol bills and household energy spending.

Across advanced economies the IMF expects headline inflation to run materially above its earlier estimates — about 4.4% for 2026 in the baseline, up from forecasts made in January. Consumers are already feeling it at the bowser and in power bills. Corporates face higher input costs, and governments are under political pressure to step in.

The IMF warns that quick, untargeted handouts or unfunded tax cuts can prolong inflation by boosting aggregate demand. That would put central banks between two bad choices: allow inflation to run, or tighten policy and risk tipping weak growth into recession. The fund's analysts warn that poorly calibrated fiscal easing now could amplify inflationary pressure and force monetary authorities to raise rates further, amplifying the hit to jobs and activity.

What the IMF says about Australia

Australia isn't immune. The IMF's report adjusts the nation's outlook downward compared with its January view. In the baseline the fund projects Australian growth at roughly 2% in 2026, a touch below earlier expectations, while average inflation will probably be near 4% this year — noticeably above the 2.9% seen in 2025.

Mastheads

Modest growth combined with persistent inflation leaves policymakers with little room to stimulate the economy without stoking prices.

The IMF notes unemployment in Australia is likely to remain low, around the mid-4% range, even as price pressures pick up. What that means practically is Australia risks joining a short list of advanced economies facing both sticky inflation and limited scope for traditional stimulus without stoking prices further.

Choices for the budget and the RBA

With the federal budget due in May, Treasurer Jim Chalmers faces a clear policy dilemma: provide targeted support to households and businesses suffering from the fuel shock, or avoid measures that could add to inflationary momentum and force the Reserve Bank to tighten more aggressively.

Chalmers has already raised the political case for diplomacy, saying a ceasefire and reopening of shipping lanes would help global markets. He has also signalled he will press trading partners at international meetings. But the IMF's message to finance ministers is fiscal restraint when inflation is elevated — or at least that relief should be tightly targeted and offset by other measures.

Markets will scrutinise Canberra's budget for signs of fiscal loosening that could push up bond yields. If Canberra opts for widespread, unfunded handouts — like broad fuel rebates or general income transfers without offsets — it risks adding to demand while supply-side shocks keep prices high. That combination could mean interest rates stay higher for longer, pushing mortgage and business borrowing costs up.

Risks beyond Australia

Gourinchas and the IMF team highlight that poorer, heavily indebted nations that import energy will feel the squeeze most painfully. Several oil-importing economies face sharply weaker growth and higher inflation, and they have limited fiscal space to shield households. In contrast, energy exporters stand to gain from higher prices; Russia's outlook, for example, was upgraded in the IMF's revisions because of its energy exposure.

Global financial markets are already repricing risk. Bond yields in many countries rose as investors priced in higher inflation, and equity markets have been volatile as traders weigh growth downgrades against corporate earnings resilience. That volatility makes it harder for businesses to plan and for policy makers to gauge when to step in.

Practical options and trade-offs

Governments can protect vulnerable households without fuelling demand by using tightly targeted payments or by tackling supply bottlenecks such as fuel distribution. One is to target relief to the most vulnerable households — for example, payments based on income or tight eligibility rules. Another is to prioritise measures that reduce supply bottlenecks, like supporting logistics and fuel distribution, rather than broad cash transfers.

Fiscal offsets matter. If a government wants to provide temporary relief, pairing it with measured spending cuts elsewhere or temporary tax measures can blunt the inflationary impulse. But those offsets are politically tough, especially close to an election or when voters are already stretched.

Monetary policy has limited room, too. The Reserve Bank can look through temporary supply shocks to some extent, but if inflation expectations drift higher, it will act. That's the IMF's core worry: uncontrolled fiscal support now could anchor higher inflation and force the RBA into a tighter stance that damages growth and jobs.

What ministers will hear in Washington

Australian officials heading to the IMF and World Bank spring meetings will hear a consistent line from lenders and market analysts — stop adding fuel to inflation. The fund's scenarios will be used to press finance ministers and central bankers to coordinate actions that avoid a self-reinforcing loop of higher prices and tighter policy.

Right now, the baseline assumes hostilities ease and energy markets calm. But the IMF's adverse scenarios — where oil averages around US$100 a barrel and disruptions persist — show how quickly a manageable shock can become a global downturn.

For Canberra, the immediate test is policy design: deliver help where it's needed without making the underlying problem worse.

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Jim Chalmers, Treasurer, said: "Australians are paying a hefty price for events on the other side of the world."

This article was created with AI assistance.