Recent military actions by the United States and Israel against Iran have driven up oil prices, bringing concerns about US inflation back into focus. If the oil price surge evolves into a persistent supply disruption, the disinflation process could stall, narrowing the Federal Reserve's room for interest rate cuts.

On March 3, Brent crude oil surpassed $85 per barrel for the first time since July 2024, rising 9% intraday. Diesel and gasoline futures also climbed. Previously, American consumers had found some relief from relatively cheaper gasoline costs amid stubbornly high expenses like food, but this buffer is now weakening.

On the inflation front, the US Consumer Price Index increased 2.4% year-over-year in January, cooling from December's 2.7%, partly due to a 7.5% annual decline in gasoline prices. However, if crude oil prices remain elevated, gasoline costs could pass through to consumers within weeks, further raising transportation and airfare expenses and amplifying the impact on overall price levels.

Neil Shearing, Chief Economist at Capital Economics, estimates that if oil prices rise to $100 per barrel for an extended period, overall inflation could increase by approximately 0.7 percentage points. For investors, the key variables are the intensity and duration of the shock. The CEO of JPMorgan stated on Monday that the inflationary impact should be limited if the military actions do not prolong. Meanwhile, former President Trump suggested the operations in Iran are expected to last four to five weeks, but the US has the capacity to continue longer.

The transmission of oil prices to inflation occurs through gasoline stations, transportation costs, and airfares. Gasoline prices are closely linked to inflation due to short supply chains, frequent price updates, and competitive markets. The US Energy Information Administration notes that crude oil prices are the single largest factor determining US pump prices.

A common rule of thumb among economists is that a 5% increase in oil prices raises the year-over-year inflation rate by about 0.1 percentage point. While a single increase may seem minor, cumulative effects can significantly lift overall price levels.

Rising oil prices also spill over into other categories. Higher trucking costs increase goods prices, while more expensive jet fuel pushes up airfares, broadening the inflationary impact.

Economists outline two scenarios: limited effect from short-term disruptions versus elevated inflation from sustained price increases. Many believe that if energy market disruptions are brief, inflation may only be elevated for one to two months. Last year, a 12-day conflict between Iran and Israel briefly pushed oil prices up by about $10 without major damage to energy infrastructure, resulting in only short-lived price pressures.

Additionally, gasoline constitutes a small portion of consumer spending. According to the latest government inflation report, gasoline accounted for only about 3% of average consumer expenditures in December, compared to 13% for food and over one-third for housing costs. This means that unless oil price increases are substantial and prolonged, gasoline alone is unlikely to dominate long-term inflation trends.

However, more severe scenarios are being considered. Alberto Cavallo, an economist at Harvard Business School, notes that if the Iran conflict leads to sustained crude price increases, the effects could appear at gas pumps within weeks and lift overall inflation.

Against this backdrop, the Federal Reserve may find it harder to overlook energy-related upside risks to inflation. Neil Shearing suggests that if oil prices significantly boost inflation, the Fed would be more reluctant to cut short-term interest rates.

The policy context is not solely dependent on energy. With the labor market stabilizing and some price pressures remaining stubborn, the case for further Fed easing has already weakened this year. If potential energy shocks combine with lingering effects from last year's tariff increases, the Fed may adopt an even more cautious stance on rate cuts.

Although the Fed often views energy shocks as temporary and prefers to wait them out rather than react immediately, one key condition supporting its three rate cuts between September and December was expectations of near-term inflation improvement. A renewed rise in inflation driven by oil prices would directly raise the bar for additional rate cuts.