Data released by the Australian Bureau of Statistics on Thursday showed the nation's labour market was still in good shape, with the unemployment rate holding steady at 4.3 per cent in March.
But a prolonged supply chain disruption will severely impact households and jobs, according to Harry Murphy Cruise, head of economic research at Oxford Economics.
If the Middle East crisis lingers into the third quarter, crude oil prices could hit $US150 to $US160 a barrel, from about $US100 now.
"Australia had an inflation problem well before this conflict kicked off," Mr Murphy Cruise said.
"So that's a tricky world to navigate and it could be even trickier if we see oil prices rise to that $US150 a barrel.
"That would push underlying inflation much closer to six per cent, broadly in line with where it was at the peak of the pandemic."
Annualised underlying inflation, which strips out volatile items, is currently at 3.3 per cent.
A further jump would give the Reserve Bank of Australia the impetus to hike the cash interest rate from 4.10 per cent.
"If we see oil prices move higher in that prolonged conflict scenario, that would push, or would force, the RBA to hike to five and a half per cent through this year," Mr Murphy Cruise said.
"All that is very bad news for households. Households are in a really tough spot at the moment. They are seeing inflation rise around them."
The situation was similar for businesses, Mr Murphy Cruise said.
"Businesses are scared. They don't know what the outlook looks like, and they've got higher input costs," he said.
A survey of 828 company directors conducted by Roy Morgan found 41 per cent believed current interest rate levels would cause a major uptick in insolvencies, while almost nine in 10 expected business costs to rise.
"While productivity concerns still dominate, the fuel and energy crisis unfolding as a consequence of the Middle East conflict will only intensify the challenges being felt in the economy," Australian Institute of Company Directors chief economist Mark Thirlwell said.
HSBC chief economist Paul Bloxham expects the central bank to hike the cash rate again at its May meeting.
"However, beyond the May meeting, we expect the RBA's decision will depend on how quickly the economy is weakening and, critically, on whether there are signs that this is feeding through to significant weakening in the jobs market," he said.
But while higher fuel costs and interest rates will weaken the labour market, it might not result in mass lay-offs, Westpac economist Ryan Wells said.
"Since the 2000s, employers have typically opted to reduce average hours worked rather than headcount during labour market downturns in order to retain flexibility," he said.
"So, absent a severe recession, we are likely to see a larger pull-back in average hours worked together with a slowing (not decline) in employment this year."
Westpac expects the unemployment rate to hit a quarter average of 4.9 per cent by the second half of 2026.
It comes as Treasurer Jim Chalmers gave a speech overnight at a meeting of G20 finance ministers in Washington, warning the effects of the Iran war would linger.
"Lasting damage has been done and the recovery will be longer and harder than any of us would like," he said.
"We won't see everything go back to normal straight away. There is no normal anymore, and the fallout from this conflict will be felt for some time even if the ceasefire sticks and the Strait reopens soon."
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