By Ann Saphir
April 7 (Reuters) – An extended disruption of the world’s oil trade from the Iran war could lift headline U.S. inflation to well over 4% by year-end, with even bigger increases possible in the short term, fresh research from the Federal Reserve Bank of Dallas suggests.
The effect on inflation expectations, however, looks likely to be modest in the short term and negligible in the longer term, according to a Dallas Fed working paper published on Tuesday.
The findings may inform Fed policymakers as they grapple with the range of possible effects on the U.S. economy from the ongoing Middle East conflict that appeared on the brink of escalation after U.S. President Donald Trump called on Iran to open the Strait of Hormuz or suffer destruction of its power plants and bridges.
U.S. central bankers had previously expected inflation would likely resume progress toward the Fed’s 2% goal later this year, as the effects of last year’s tariff shock receded.
The surge in oil prices – most visible to U.S. consumers as sharply higher gasoline prices — threatens to reverse that trend. Fed policymakers worry about the pocketbook effect of rising prices, but also the chance that another jump in inflation could lead so far largely stable inflation expectations to become unmoored.
“The higher you are above the 2% target, the more it just gets ingrained into cost-plus contracts where people come down and they say, ‘well, if inflation is going to be 5%, I need a wage increase of 6%’; and then the business says, ‘if we’ve got to pay wage increases of 6%, we’ve got to raise prices 7%,'” Federal Reserve Bank of Chicago President Austan Goolsbee said at the Detroit Economic Club on Tuesday. “And that’s a very uncomfortable situation for the central bank or for anyone.”
The Dallas Fed working paper laid out the likely impact on U.S. inflation under a range of scenarios for the strait, the passageway for 20% of the world’s oil that has been effectively closed for five weeks.
A closure of the strait for one quarter could lift inflation in March by 5.2 percentage points on an annualized basis, though the effect would quickly dissipate, likely leaving fourth-quarter inflation elevated by 0.35 percentage points.
But a closure lasting three quarters, or nine months, would drive the price of oil from the current $115 a barrel to $167 and push up fourth-quarter inflation by as much as 1.8 percentage points, they found.
Year-over-year inflation as measured by the Personal Consumption Expenditures Price Index was 2.8% in January. The Fed targets 2%.
The effect on core inflation, which excludes food and energy prices, would be 0.18 percentage points if the Strait of Hormuz were closed for one quarter, and about 0.49 percentage points if the closure lasts three quarters, the researchers said. Core inflation measured 3.1% in January.
The increase in household inflation expectations would be more limited, they found.
One-year expectations could rise as much as 0.8 percentage points, according to the paper. But five- to 10-year expectations, which Fed policymakers are most concerned about, would increase by 0.09 percentage points at most.
(Reporting by Ann SaphirEditing by Rod Nickel)
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