Forget This Evening's CPI! Oil Price Rise Begins to Show Impact on U.S. Inflation Starting in March

The sharp surge in oil prices driven by Middle East tensions is reshaping market expectations for U.S. inflation trends. While most analysts believe that only sustained shocks pose real threats, the near-term upward push on inflation from energy prices is nearly certain to materialize in the March data.

According to Wind Trading Desk, Citi’s report released on March 9 indicated that as of March 8, the average retail gasoline price in the U.S. had risen by approximately 17% compared to the end of February. Based on this, Citi has assumed a monthly average gasoline price increase of about 15% for March, which is expected to drive a roughly 7% month-over-month rise in the overall CPI energy component.

The lagged effects of airfares and core goods will manifest the second wave of oil-driven inflation in the second quarter. Citi expects airfare year-over-year increases of around 10% to 15% by mid-year, while core goods prices are also likely to face upward risks during the second quarter. Meanwhile, the forecast for February core CPI is a 0.23% month-over-month rise, and January core PCE is projected at a 0.37% month-over-month increase (the inflation risk from rising oil prices is not significant in February’s data).

Significant and sustained oil price spikes trigger prolonged inflation cycles. Currently, market expectations for the inflation trajectory are short-term uptick with long-term stability.

Gasoline and Utilities: Fastest Channels of Transmission

Citi forecasts a month-over-month increase of about 7% in the overall energy component in March, directly boosting CPI. For utility prices, although natural gas prices have risen alongside Middle East developments, domestic U.S. increases remain far below those seen in Europe.

Historical patterns suggest a one-month lag in the transmission of natural gas prices into the CPI’s gas utilities subcomponent, meaning related pressures may only appear in the April CPI data.

Each 10% rise in oil prices pushes up PCE inflation by about 10 basis points in the near term, but this effect gradually fades over roughly one year as high oil prices suppress demand for other goods and services. The drag on consumer spending offsets the inflationary impact roughly equally—both around 10 basis points.

Airfares and Core Goods: Deepening Transmission Chain

If oil prices remain elevated, inflationary pressure will seep into core inflation components, with airfares being one of the most sensitive transmission nodes.

Middle East tensions have constrained jet fuel supply, causing a sharp rise in jet fuel prices recently. Airfares typically lag behind jet fuel price movements by one to three months, and significant fare hikes only occur when high jet fuel prices persist for several weeks.

Citi has slightly upgraded its near-term airfare outlook, forecasting year-over-year increases of about 10% to 15% by mid-year, while seasonal price declines in the second quarter may be more muted.

The recent surge in energy prices has clearly increased the risk of further strength in goods prices in the second quarter.

If PPI goods prices continue strong growth for another one or two months, it will likely prompt an upward revision of both CPI and PPI core goods forecasts.

Inflation Expectations: Short-Term Upward, Long-Term Stable

Currently, market dynamics show a divergence: short-term expectations rising, long-term ones stable.

Short-term inflation expectations have risen alongside gasoline price increases, and short-term consumer inflation expectations may follow suit. However, the market’s 5-year/5-year forward inflation expectations have actually declined recently, reflecting expectations of slower economic growth and a weakening labor market.

Over the past 50 years, market inflation expectations have been sensitive to oil price fluctuations at high frequencies—but in most cases, these upward moves were not sustained (only a few instances such as post-pandemic with Ukraine war spillovers, and the 1999 OPEC production cuts led to lasting re-pricing of inflation expectations).

Long-Term Inflation Path: Labor Market Is the Key Variable

Weaker labor markets will limit firms’ pricing power, making the secondary transmission effect of this oil shock on core inflation weaker than in the post-pandemic inflation cycle.

Its latest forecast shows core PCE year-over-year growth at around 3.0% in the first quarter of this year, followed by a gradual decline, with a projected drop to about 2.4% by end-2026—but still above the Fed’s 2% target.

If the oil shock is limited in scale and duration (below $100/barrel and less than six months), the Fed tends to temporarily ignore energy price volatility.

But if the shock intensifies and persists, the coexistence of inflation and slowing economic growth could create stagflation risks, forcing the Fed into a dilemma and potentially pushing back the interest rate cut window further.