The conflict with Iran: FAQ

This is obviously a very fluid situation and as the facts on the ground evolve so too will the economic impact. As a framing, just bear in mind that, absent a prolonged war and major long-term disruptions to key shipping routes in the Strait of Hormuz, the impact on U.S. economic growth, inflation and monetary policy should remain modest. Of course, the opposite also could be true.

Our model simulations of 10% and 30% sustained increases in oil prices do not come close to generating a U.S. recession or markedly changing the trajectory for core inflation. Headline inflation does move higher via higher energy prices for the consumer, but the drag on real consumer spending and thus economic growth is muted in these scenarios (0.1-0.2 percentage points for the year).

Central banks typically look through oil-driven inflation shocks, and we expect this time to be similar. We expect the FOMC to take the long view, and the weekend's events probably will not have a major impact on the Federal Reserve's reaction function. Our forecast for 50 bps of rate cuts this year remains unchanged. Similarly, we are not making any changes to our G10 or EM central bank forecasts at this time. In the very near term, we expect central banks around the world to remain in wait-and-see mode as they await additional clarity on the geopolitical situation.

What happens to US inflation in the wake of an Oil-price shock?

• Oil prices were already moving up over the past couple of weeks in anticipation of potential escalation, but the price of Brent crude has risen $7 since the U.S. strikes, or about 14% above its February average. Henry Hub natural gas prices are also up 6% in the wake of the strikes (Figure 1). Higher oil prices would need to persist to meaningfully impact the U.S. economy, as a sharp spike followed by a rapid normalization would not have much of an impact.

• To assess the potential U.S. macro impact from the military escalation, we run two scenarios: (1) a sustained 10% rise in Brent oil prices from a baseline expectation of around $65/barrel on average in Q1, and (2) a larger, sustained 30% rise in oil prices, which is closer to the spike that occurred immediately following Russia's invasion of Ukraine in early 2022.
• A 10% sustained rise in oil prices would add roughly 0.3 percentage point to the year-over-year rate of headline consumer price inflation in the second and third quarter of this year, whereas a 30% rise would lift the one-year change closer to a full percentage point (Figure 2). The impact on core inflation would be much more modest (a few tenths with a 30% rise in oil prices) but not zero. This upward pressure on oil prices would reverse what has been one notable tailwind for disinflation and consumer spending over the past year; since last January, energy goods prices are down 7.3% compared to the 2.4% increase in headline CPI.

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