Global banking giant HSBC has issued a stark warning that Australia may be just weeks away from entering its most damaging economic period since the 1970s, with a rising stagflation threat driven by spillover effects from the ongoing Middle East conflict. The bank’s official projection expects Australia to slip into an outright stagflation environment by the June quarter of this year, when official national economic data is scheduled for public release.
By June, HSBC predicts Australia will see three core stagflation indicators align: a contraction in gross domestic product, sustained acceleration in cost-of-living pressures, and a noticeable uptick in national unemployment rates. Paul Bloxham, HSBC’s chief economist for Australia, noted in a client note that a stagflationary shock has already reached the country’s borders, and that the nation will experience stagflationary conditions in two of the next three quarters.
“Could it be genuine stagflation – like the 1970s? This depends on how persistent it is. And, importantly, on what policymakers do next,” Bloxham wrote.
Stagflation is widely recognized as the worst-case scenario for modern economies, characterized by simultaneous slowdown in economic activity and rising consumer prices that leaves policymakers with few viable policy options. Australia last faced a full stagflation crisis in the mid-1970s, triggered by a global oil price shock that mirrored the current market disruption. While Bloxham stopped short of declaring a full 1970s-style repeat is inevitable, he emphasized that risks are growing rapidly for Australian economic decision-makers.
“Australia faces a stagflationary shock, and we expect that outright stagflation is a rising risk. The aim for policymakers ought to be to keep it brief and optimal policy settings could help to make it so,” Bloxham added.
He explained that Australia entered the current crisis in a vulnerable position, with inflation already running well above the Reserve Bank of Australia’s 2-3% target at 3.7% before the Middle East conflict escalated. Unlike many other advanced economies, Australia’s domestic economy has little to no spare capacity to absorb external shocks, creating a higher risk that fuel-driven inflation will become embedded in long-term consumer and business inflation expectations.
Against this backdrop, Bloxham projects that the Reserve Bank of Australia (RBA) will raise its official cash rate for the third consecutive month in May, completely undoing the three rate cuts implemented in 2025. If the forecast holds, the cash rate will climb from its current 4.1% to 4.35%.
The current volatility stems from the escalation of conflict between US-allied Israel and Iran that began in late February, which has led to disruption of shipping through the Strait of Hormuz – the critical global chokepoint through which roughly one-fifth of the world’s daily oil supplies pass. Before the conflict erupted six weeks ago, global benchmark oil traded at roughly $US56 per barrel; it has since surged to around $US100 per barrel. For Australian consumers, every $US10 per barrel increase translates to an extra 10 Australian cents per litre of fuel at the pump, directly amplifying cost-of-living pressures.
The threat of stagflation has already been acknowledged as a worst-case outcome by senior RBA officials. During a fireside chat with the Money Marketeers in New York, RBA deputy governor Andrew Hauser described stagflation as a “central banker’s nightmare” that complicates the central bank’s core mandate.
“I don’t think those surveys tell you a lot about what consumption is going to do but, if they are right, we have a big income shock coming our way,” Hauser said. “It is the central bankers nightmare, you know, inflation up, activity down and judging the balance between the two is how we earn our money.”
Hauser added that the Middle East-driven oil price shock has made it far more difficult for the RBA to return inflation to its 2-3% target range. “I wouldn’t say we have high confidence that we’ve set interest rates at the right level because you never do have that high confidence. But we’re going to have to monitor this new shock pretty carefully,” he said. “I think it is easy to see that upside inflation pressure. More important for us now is to think through what the medium-term impact might be.”
A key variable that will determine how long any stagflation period lasts is the Albanese government’s upcoming May federal budget, Bloxham argued. He warned that expansionary fiscal policy, particularly broad-based cost-of-living support measures that are not targeted, would only worsen persistent inflation pressures by boosting aggregate demand at a time of constrained supply.
Earlier this month, the government cut the national fuel excise by roughly 32 Australian cents per litre to ease pressure on motorists. Data from Westpac shows that total national fuel spending has increased by $236.7 million compared to the same period last year, and remains 16.2% higher year-on-year. While Westpac projects fuel spending growth will plateau as prices stabilize and households adjust their spending habits, Bloxham said the broad excise cut is actively worsening stagflation risks.
“Recent cuts to fuel excise do exactly this – they support more spending by all households and lower the price of fuel when fuel is the product in short supply, preventing the price mechanism from working properly,” he explained. “Targeted, timely and temporary fiscal support ought to be deployed. Any more than a targeted approach will mean the RBA could need to set tighter monetary policy than otherwise.”
Treasurer Jim Chalmers has acknowledged the extreme uncertainty created by the Middle East conflict, but says the government will strike an appropriate balance between near-term support for households and long-term fiscal responsibility in the upcoming budget. “We are putting together the budget in very uncertain, very unpredictable and very volatile global conditions,” Chalmers told reporters last Friday. “It will strike the right balance between the pressures on people in the here and now and our intergenerational responsibilities. I’m confident that we’ll get those balances right, but I’m not complacent about it because we are hostage to developments in the Middle East.”