‘Nothing worse than higher oil prices’ as Fed fights inflation

Oil’s upward price movement is making the Federal Reserve’s path toward a 2% inflation target more difficult.

The crude market’s rise is likely to have lifted overall inflation last month. And while core inflation — which strips out food and energy costs — has been on a downward trend, economists worry that higher energy prices could increase input costs for goods and services, leading companies to raise prices on everything from airfares to furniture.

“I’d say the rise in oil prices since late June/early July has clearly put upward pressure on gasoline prices and will lead to a large boost in the August headline CPI [Consumer Price Index],” Omair Sharif, president of Inflation Insights, tells Yahoo Finance.

He added, “You may see higher fuel surcharges seep into higher prices for food, for food services, and a variety of goods that are moved by truck — for example furniture, appliances. You can also see higher jet fuel costs make their way into higher airfares.”

August’s Consumer Price Index report, slated for release Wednesday, is expected to show prices increased 0.5% from the prior month, an acceleration from July’s 0.2%. Year-over-year inflation is expected to jump 3.6% versus 3.2% in July.

Core CPI is expected to stay unchanged but could surprise to the upside because of the higher transportation fuel costs Sharif referenced.

Earlier this week, United Airlines, Southwest, and Alaska Air all warned of higher fuel costs in the third quarter.

Since mid-July, “jet fuel prices have climbed over 20%,” noted United Airlines in an 8-K filing on Wednesday.

Why oil prices are rising

West Texas Intermediate (CL=F) and Brent crude futures (BZ=F) have rallied more than 25% since late June. Output cuts are putting a squeeze on the oil market, despite China’s slower-than-expected economic recovery and increased production output by US producers.

Earlier this week Saudi Arabia announced an extension of its unilateral production cuts for the next three months. Russia also reduced its exports by 300,000 barrels per day through year-end. These cuts are in addition to OPEC+ reductions that started at the end of last year.

Wall Street analysts are starting to talk about $100 oil if momentum in the oil market continues.

In July, the Federal Reserve raised interest rates for the 11th time since March 2022, in what officials hinted could be the first of two rate hikes considered for the rest of the year.

U.S. Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a closed two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, U.S., July 26, 2023. REUTERS/Elizabeth Frantz

US Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a closed two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, U.S., July 26, 2023. (Elizabeth Frantz/REUTERS)

The Fed is expected to hold rates steady when it meets on Sept. 19 and 20 as it continues to watch inflation data and make sure it’s still cooling.

Wall Street analysts have walked back their calls for a recession, with Goldman Sachs bringing down the probability to 15% in the next year. A relatively strong, though slowing, labor market is prompting speculation that the Fed may be able to pull off a ‘soft landing’.

“Everything is consistent with a soft landing, but you throw in the mix higher oil prices — if they keep going higher and stay higher, that could be a problem,” Mark Zandi, Moody’s Analytics chief economist, told Yahoo Finance Live this week.

“There’s nothing worse than higher oil prices,” said Zandi. “There’s nothing more deleterious to the economy than higher oil, gasoline prices that slows growth. It sucks purchasing power of consumers. And it adds to inflation expectations.”

The economy’s trajectory is looking less optimistic the longer consumers and companies are forced to deal with elevated energy costs.

“The more sustainable [the increase] becomes, the more of an impact it could have on corporate profits going into the next several quarters. And of course it can complicate this soft landing situation that the market has been baking in,” Amy Kong, partner at Corient, told Yahoo Finance this week. 

“We wouldn’t be surprised to see inflation potentially picking up a little bit, or just not slowing down as much. That obviously will throw a wrench into the Fed story of potentially pausing for the time being,” she added.

Ines Ferre is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre.

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