Inflation Expected to Accelerate Sharply Following Iran Conflict Oil Price Surge
Inflation was likely already elevated in February, even before the dramatic spike in oil and gas prices over the past two weeks, which is now anticipated to send consumer costs soaring in the coming months. According to a survey of economists by data provider FactSet, consumer prices are forecast to have risen 2.5% in February compared to a year earlier when the Labor Department releases its figures. This represents a slight increase from the 2.4% recorded in January.
Core prices, which exclude the volatile food and energy categories, are expected to have also increased by 2.5% in February, matching January's figure, which was the lowest in five years. However, this data provides only a snapshot of inflation before the Iran war launched on February 28, which has caused violent fluctuations in oil prices due to a rare shutdown of shipping lanes through the Persian Gulf.
Gas Prices Jump, Threatening Broader Economic Impact
Gas prices have already surged and are projected to push inflation much higher when March figures are released next month. This price spike is likely to unnerve inflation fighters at the Federal Reserve and could slow consumer spending, weighing on the broader economy. While the increase might be a one-time event and potentially reverse if the war ends soon, as hinted by President Donald Trump, the spike in gas prices threatens to worsen inflation for at least a few months.
Americans are already weary from nearly five years of stubbornly high prices, making "affordability" a thorny political issue for congressional Republicans facing midterm elections later this year. Oil prices soared to nearly $120 a barrel late Sunday before rapidly falling back on Monday after Trump suggested the conflict would be a "short-term excursion." Nevertheless, he has also threatened ongoing attacks, and it remains unclear when the conflict might end.
Analysts Warn of Further Price Increases if Strait of Hormuz Remains Closed
Some analysts warn that prices could move much higher if the Strait of Hormuz remains closed, which has removed roughly three-quarters of the Persian Gulf region's oil production from world markets, according to Wood Mackenzie, an energy analytics firm. The firm forecasts that oil prices could soar to $150 a barrel in the coming weeks if shipments do not resume.
This would push gas prices even higher in the United States, where they jumped to $3.54 a gallon on average nationwide on Tuesday, according to AAA, marking an increase of about 20% in just one month. Over time, higher gas prices will lift other costs, including airfares and shipping expenses, potentially making groceries and restaurant meals more expensive.
Given the ups and downs of oil prices—U.S. crude prices fell nearly 9% to $86.55 on Tuesday afternoon—it is difficult to forecast the long-term impact. If shipments resume within a week or so, gas prices will likely decline fairly soon, though they typically fall much more slowly than they rise.
Inflation Projections and Federal Reserve Dilemma
Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, expects inflation could jump by as much as 0.8% or 0.9% in March compared to the previous month, which would be the largest monthly gain in nearly four years. Yearly inflation could easily surpass 3% in that case and potentially near 4% in the following months. In contrast, overall prices are projected to have climbed just 0.3% in February from the previous month.
The jump in gas prices so far this month has been the largest since March 2022, and before that since June 2009, Rosner-Warburton noted, describing it as "enormous" and "highly unusual." Core prices will be much less affected this month but could tick higher over time as more expensive gas pushes up airline fares and other transportation costs. Core inflation is expected to have increased 0.3% in February from the previous month.
Even if the sharp rise is short-lived, it will almost certainly delay any interest-rate cut by the Federal Reserve, which meets next week. The Fed cut its key rate three times last year before leaving it unchanged at its last meeting in January. The central bank is deeply divided over whether to keep its rate at the current level of about 3.6% to push inflation closer to its 2% goal or reduce it to support borrowing, spending, and hiring.
Weak Jobs Report Complicates Fed's Decision-Making
Last Friday, the government reported an unexpectedly sharp job loss in February, with employers slashing 92,000 jobs and the unemployment rate ticking up to a still-low 4.4% from 4.3%. This weak jobs report puts the Fed in a particularly difficult position: it would normally reduce rates to boost growth and hiring but typically raises rates—or at least keeps them steady—if concerned about inflation.
Austan Goolsbee, president of the Federal Reserve Bank of Chicago, commented on Bloomberg Friday, "That's always the worst-case scenario for the central bank. As we get more uncertainties, I kind of think that the time at which it makes sense to act keeps getting pushed back."
Gregory Daco, chief economist at EY-Parthenon, noted that normally the Fed would expect an oil price shock to have at most a temporary impact on inflation and might still cut rates if the economy needed lower borrowing costs. However, Fed policymakers were burnt just a few years ago when they initially said the post-COVID inflation spike in 2022-23—the worst in four decades—would be temporary. As a result, they will be reluctant to take the risk of prematurely lowering rates.
A few officials even mentioned during the January meeting that they might have to hike rates soon, rather than cut them, according to the meeting's minutes—and that was before the Iran war. "They do not want to be burned again," Daco said.
