Forget about tomorrow's CPI! The impact of rising oil prices on U.S. inflation only began to appear in March.

The surge in oil prices triggered by the Middle East situation is reshaping market expectations for the trajectory of US inflation. Although most analysts believe that sustained shocks are the real threat, in the short term, the rise in energy prices is almost certain to be reflected in the March inflation data.

According to Chase Wind Trading Desk, Citigroup’s report released on March 9 shows that as of March 8, the average US retail gasoline price had risen about 17% from the end of February. Based on this, Citigroup assumes an average monthly rise in gasoline prices of about 15% for March, and expects the energy component of overall CPI to increase about 7% month-on-month.

The lag in airfares and core goods will reflect oil price’s second wave impact on inflation in the second quarter. Citigroup forecasts the year-on-year surge in airfares at about 10% to 15% in mid-year, with core goods prices also facing upside risk in the second quarter. It also predicts February core CPI to rise 0.23% month-on-month, and January core PCE to rise 0.37% month-on-month (oil-related inflationary risks are not prominent in the February data).

Bank of America offers a longer-term historical perspective. According to BofA's research report on March 6, data from the past 50 years shows that only "significant and sustained" oil price surges trigger prolonged inflation cycles. Currently, market expectations for inflation are short-term upside, long-term stability.

Gasoline and Utilities: Fastest Transmission Channels

The transmission of oil price increases to inflation shows a distinct order in the time dimension, among which gasoline prices are the most responsive segment.

Citigroup predicts a month-on-month increase of about 7% in the energy component for March, which will directly push up CPI. As for utilities prices, natural gas prices have risen with the Middle East situation, but domestic US increases are far less than Europe.

Historical patterns show that there’s about a one-month lag in the transmission of natural gas prices to the gas utilities component in CPI, meaning related pressure may appear in April’s CPI.

BofA estimates that every 10% increase in oil prices will push up PCE inflation by about 10 basis points in the new future, but as high oil prices suppress demand for other goods and services, this effect will fade within about one year. The drag on consumer spending is about as large as the inflationary boost, both around 10 basis points.

Airfares and Core Goods: Deeper Transmission Chains

If oil prices remain high, inflation pressure will penetrate into core inflation components, with airfares being the most sensitive transmission point.

Citigroup research points out that the Middle East situation has restricted aviation fuel supply, causing jet fuel prices to surge recently. Airfare prices typically lag jet fuel prices by 1 to 3 months, and only when jet fuel stays high for several weeks will airfares rise substantially.

Citigroup has slightly raised short-term airfare price forecasts, expecting year-on-year increases of about 10% to 15% by mid-year, while the usual seasonal price declines in the second quarter may be narrower.

For core goods prices, Citigroup believes that with limited new tariffs, upward price pressure for goods was originally expected to ease in coming months. However, rising energy prices have clearly increased the risk of goods prices strengthening further around the second quarter.

Citigroup states that if PPI goods prices continue robust growth for another month or two, it will likely prompt an upward revision of CPI and PPI core goods forecasts.

Inflation Expectations: Short-Term Upside, Long-Term Stability

The trajectory of inflation expectations is key for the Fed’s policy decisions. Currently, markets are showing a differentiated pattern of short-end upside, long-end stability.

Citigroup notes that short-term market inflation expectations have risen with gasoline prices, and short-term consumer inflation expectations may do the same. However, market 5 year/5 year forward inflation expectations have recently declined, reflecting expectations of slower economic growth and weaker labor markets.

BofA’s research confirms this view. Its analysis shows that over the past 50 years, market inflation expectations are sensitive to oil prices in high frequency, but in most oil price surges, the upside in inflation expectations hasn’t persisted (only in a few cases, such as post-COVID plus the Russia-Ukraine war and in 1999 after OPEC’s production cuts, were lasting repricing triggered).

Long-Term Inflation Path: Labor Market is Key Variable

No matter how this round of oil price shock plays out, both Citigroup and BofA stress that labor market conditions are the main constraint on whether inflation can persist. Citigroup states that a relatively weak labor market will limit firms’ pricing power, making this round of oil price shock’s secondary effects on core inflation weaker than in the post-COVID inflation cycle.

Their latest forecasts show that core PCE year-on-year increases will be about 3.0% in the first quarter of this year, and then decline gradually, possibly reaching about 2.4% by the end of 2026. But this is still higher than the Fed’s 2% policy target.

In this context, BofA believes the Fed is likely to hold its position in the near term. If the oil price shock is limited in scale and duration (less than $100/barrel and under six months), the Fed is inclined to temporarily ignore energy price volatility.

But if the shock persists and strengthens, the risk of stagflation—coexisting inflation surge and slowing economic growth—will put the Fed in a dilemma, possibly further postponing the window for rate cuts.

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