Escalating tensions between Iran, Israel and the United States have pushed global oil markets into renewed uncertainty, with analysts warning that any sustained disruption to Middle Eastern supply routes could send prices sharply higher.

The conflict, which has drawn in regional proxies and prompted retaliatory strikes across multiple fronts, has already rattled energy markets that were still absorbing the effects of Russia’s ongoing war in Ukraine. The International Energy Agency has tracked the market impact of geopolitical disruption on oil supply, while the Reserve Bank of Australia has noted the sensitivity of domestic inflation to global energy price movements.

“The oil crisis is a negative shock not only for the Australian economy, but for the global economy as a whole,” said Nalini Prasad, Senior Lecturer in the School of Economics at UNSW Business School.

“Higher oil prices lead to higher petrol prices in Australia. Now you need petrol essentially to deliver goods and services to consumers in the economy. The problem we’re having now is essentially these oil price increases are coming at a time when inflation in the economy is already higher than where we would like it to be.”

Australia, as a significant importer of fuel, faces direct exposure to any sustained price spike – a vulnerability the Australian Bureau of Statistics has documented through its consumer price index data. It is against this backdrop that Dr Prasad offered a clear-eyed assessment to the UNSW Centre for Ideas of what the unfolding crisis could mean for Australian households and businesses.

Inflation: the challenge that won’t go away

Australia entered this period of geopolitical instability with inflation that has already proved stubborn. The Reserve Bank of Australia’s most recent statement on monetary policy showed headline inflation remaining above the central bank’s 2-3% target band for an extended period, while the OECD’s economic outlook for Australia identified persistent services inflation as a complicating factor for policymakers.

“The key challenge facing the Australian economy is inflation,” said Dr Prasad. “Inflation’s been higher than expected for longer than expected. And higher inflation essentially means your income can buy fewer and fewer goods and services, and this leads to a decline in living standards over the next few months.”

If oil prices continued to rise, Australians should expect higher inflation, according to Dr Prasad: “We’re going to start hearing lots more terms about inflationary pressures and cost of living pressures as well.”

Policy under pressure: the risk of losing control

The IMF has examined how supply disruptions complicate monetary and fiscal policy coordination, warning that geopolitical shocks put the two policy arms into conflict and that inaction or mixed signals from authorities could allow a short-term disruption to become a deeper structural problem.

Dr Prasad affirmed the importance of this observation and said the government's and the Reserve Bank of Australia's responses will be critical. “Policy mistakes can actually lead a temporary crisis to become more prolonged. And if you have a more prolonged crisis, essentially, the government and the central bank lose control of inflation expectations.

Learn more: Five important ways to reduce Australia’s supply chain risks

“And once you lose control of inflation expectations, well, if you’re a consumer, you expect prices to start rising rapidly in the future. It’s in your incentive to start consuming more today. So you’re going to start hoarding, you’re going to start buying more today, and that’s going to lead to even greater inflation.

“Now, if you’re a business and you expect that consumers aren’t going to buy in the future because they expect inflation to be higher in the future, then you’re not going to want to produce in the future, and that’s going to lead to even more unemployment in the future,” said Dr Prasad.

“So, the key is to make sure that inflation remains contained and that consumers know that inflation will remain contained.”

The spectre of stagflation

The word stagflation had begun to re-enter public and financial commentary, and for good reason. The 1970s oil shocks produced the most documented case of stagflation in modern economic history, a period the RBA examined directly in its research on oil price shocks, monetary policy and stagflation.

More recently, the OECD’s April 2026 analysis of the current energy price spike found that exposure to the shock differed markedly across countries depending on their reliance on oil and gas imports. Research modelling Australia’s specific exposure to the current Middle East conflict found the country faced a genuine stagflation risk, with rising prices and slowing growth a plausible outcome if the disruption persisted.

“Stagflation refers to rising inflation, unemployment and slowing output growth,” said Dr Prasad.

“Now, stagflation is an uncomfortable position for the economy to be in. These are three things that typically don’t go together. Usually, when economic growth is strong, we have high inflation, or when economic growth is weak, we have low inflation. Stagflation breaks the link between all these variables, and that’s why it’s hard to deal with.”

The media has also started talking about stagflation because high oil prices were often associated with it, according to Dr Prasad. “When you have stagflation, the government faces a trade-off between controlling unemployment or controlling inflation.”

Any policies that reduced unemployment would increase inflation, while any policies that reduced inflation would increase unemployment. “What we know from history is that the government should prioritise reducing inflation,” said Dr Prasad.

“And so that typically would involve something like increasing interest rates. They’re going to increase interest rates when households are already facing cost-of-living pressures. But we know from history that this short-term pain is necessary in order to avoid longer-term increases in unemployment in the future.”

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FAQ: Oil prices, inflation and stagflation

What is an oil price shock, and how does it affect inflation? An oil price shock is a sudden increase in oil prices that raises production and transportation costs, contributing to higher inflation.

Why is Australia vulnerable to rising oil prices? Australia imports a significant share of its fuel, making domestic prices sensitive to global supply disruptions.

What is stagflation, and why is it a risk now? Stagflation occurs when inflation rises alongside weak economic growth and higher unemployment, often linked to energy price shocks.

How do oil prices influence the cost of living in Australia? Higher oil prices increase petrol and transport costs, which flow through to goods and services across the economy.

What role does the Reserve Bank of Australia play during inflation shocks? The RBA adjusts interest rates to manage inflation expectations and maintain price stability.