While tensions between the US and Iran continue to escalate, Goldman Sachs believes the inflationary impact of the conflict on the US is fading and is insufficient to destabilize inflation expectations, leading the firm to forecast that the Federal Reserve will keep interest rates unchanged this year.

In a research report dated July 12th, Goldman Sachs economists David Mericle and Pierfrancesco Mei noted that the commodity price shock has significantly reversed, and the pass-through effect on inflation is expected to weaken considerably in the third and fourth quarters.

Core PCE inflation is projected to record a monthly increase of 24 basis points in June, subsequently holding within a range of 20 to 23 basis points. This trajectory is sufficient for the Federal Reserve to maintain its current policy stance throughout its remaining meetings in 2026, though with extremely limited room for error.

A Key Assumption: Conflict Does Not Escalate Significantly

A crucial premise for this outlook is that the conflict does not escalate substantially further. If oil prices were to return to $100 per barrel, it would add an extra 3 to 4 basis points to monthly core inflation. More importantly, a new supply shock would heighten market concerns about inflation expectations becoming unanchored, an impact on monetary policy debates that could far exceed the numerical effect.

Commodity Price Shock Has Largely Reversed

Despite renewed attacks between the US and Iran last week, oil prices have risen only modestly and remain roughly 30% lower than their wartime peaks seen from late April to early May. Retail gasoline prices have fallen 15% from their peak, which should help push the headline CPI lower in June. Jet fuel prices have dropped 35%, which will likely lower airfare costs in the coming months.

Prices for other export commodities from the Persian Gulf have also retreated significantly from their wartime highs. Prices for products like methanol, polyethylene, and nitrogen fertilizers are near pre-conflict levels, with only sulfur and ammonia prices remaining elevated.

Shipping and air freight costs have continued to rise, but the impact is limited. The report notes that international transport costs account for only 1% to 2% of US consumer goods import costs, and the current increases are far smaller than those seen in 2021-2022, suggesting a relatively mild impact on consumer prices. Oil flows from Persian Gulf nations dipped after the first tanker attack on June 27th, but the 7-day average remains above wartime lows. While global visible oil inventories have not been significantly replenished, they are also not at abnormally low levels.

Inflation Pass-Through to Fade Rapidly in Q3 and Q4

Goldman Sachs employed two sets of statistical tools to assess the ongoing impact of the conflict on consumer prices.

The first tool is a model for the pass-through of commodity prices to consumer prices, encompassing refined product spreads, transport costs, and spillover effects from other impacted economies. The model indicates that the incremental impact of commodity prices on monthly core PCE inflation peaked in the second quarter. Assuming no further escalation, this impact will decline notably in the third quarter and narrow further in the fourth.

The second tool uses shortage indices and supply chain pressure indicators developed by economists at the Federal Reserve Board and the New York Fed to assess broader disruption effects beyond energy. Data shows these indicators rose far less during the Iran conflict than during the pandemic period and had already retreated significantly from their peaks prior to last week's new round of attacks. This model similarly suggests that, barring further escalation, the conflict's impact on monthly inflation peaked in May-June and will decline substantially in the third and fourth quarters.

Conflict Impact Not Enough to Unanchor Inflation Expectations

A core concern for Federal Reserve officials is that prolonged, cumulative supply shocks could ultimately destabilize inflation expectations. However, based on current data, this risk appears manageable.

The report points out that market-based measures of inflation compensation remain subdued, a point recently emphasized by Fed Chair Wash. Some consumer inflation expectation surveys, particularly the University of Michigan survey, show elevated readings, but their reliability is increasingly questioned as consumer survey responses have become more politicized and less correlated with macroeconomic trends.

A composite indicator of persistent inflation risk sends a similar signal. This indicator tracks various pathways through which an initial shock can evolve into self-reinforcing high inflation, including normalization of firm price expectations, rising inflation expectations, and a wage-price spiral. The indicator suggests that, without further escalation, the inflationary shock from this war is neither severe nor long-lasting enough to trigger widespread inflation contagion.

Inflation Path Supports Fed Holding Steady All Year

Synthesizing the above analysis, core PCE inflation is expected to record a 24-basis-point monthly rise in June, then remain in a 20-23 basis point range in subsequent months. Additional inflationary pressures from tariff effects and potentially overestimated AI-related demand are also expected to gradually fade in the second half of the year.

On an annualized basis, a methodological adjustment by the Bureau of Economic Analysis in August is expected to lower the core PCE year-on-year growth rate by about 0.2 percentage points to 3.2%. However, the annual rate is projected to decline only modestly further before the Fed's remaining meetings this year.

This inflation path would allow the Federal Reserve to keep interest rates unchanged for the remainder of 2026, albeit with very little margin for error, and some divergence of opinion within the FOMC may emerge.

If the conflict re-escalates and pushes oil prices back to $100 per barrel, the model indicates monthly core inflation would rise an additional 3 to 4 basis points. However, the impact of a new supply shock on monetary policy discussions could far exceed the numbers—it would increase uncertainty about when supply shocks will end and amplify fears that inflation expectations could ultimately become unanchored.