According to experts, the Federal Reserve’s efforts to cool the economy have been complicated by a surprise production cut announcement this week from Saudi Arabia and several other OPEC+ oil exporters. This news also has the potential to increase inflation in the US.

As Russia invaded Ukraine last year, energy costs soared all over the world, driving global inflation just as the world’s biggest economies were starting to rebalance following the epidemic.

Since then, a decline in energy costs has contributed to a slowing in US inflation, which, according to the Consumer Price Index, has dropped from a 40-year high of 9.1% in June to 6% in February, year over year.

On February 8, 2023, in the Russian city of Omsk in Siberia, flue gas and steam are seen rising from chimneys and smokestacks of an oil refinery during the setting sun on a chilly day.
The implications of OPEC’s reduction for Putin and Russia
According to the Bureau of Labor Statistics, energy prices, which account for about 7.5% of the overall index, increased by 5% in February relative to the same month last year, a much smaller increase than the 41.3% increase seen in June.

Now that oil prices are soaring once more, the headline inflation rate may possibly increase. However, Consumers are already paying more at the pump; the national average price per gallon was $3.55 on Thursday, up from $3.40 a month earlier, according to AAA.

Core inflation may also be impacted.
Core inflation, which excludes volatile food and energy costs, is one of the key points of concern for Fed policymakers as they weigh various economic data to guide their decisions. Yet, if oil prices stay high enough, they may eventually cause core prices to increase.

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According to Sarah House, senior economist at Wells Fargo, “the Fed views OPEC decisions as primarily geopolitical, but they can impact production of goods and the transportation of other items,” she told CNN. “Higher oil prices can bleed into that core component, which the Fed does tend to focus on a little bit more in terms of setting policy.”

For instance, plastic resin, a byproduct of crude oil, is used to make commonplace objects like bottles, wires, and clothing. The price of jet fuel has a significant impact on airfare.

Consumer spending is crucial.
By dragging on consumer confidence and spending, both of which were pleasantly strong at the start of the year but have recently started to cool, higher energy costs reduce demand overall.

When petrol prices hit $5 per gallon in June of last year, the University of Michigan’s measure of consumer sentiment reached its lowest point ever. Since then, as gas costs have fallen, it has become better.

Saudi Arabia’s Ras Tanura oil terminal and refinery may be seen in the background. May 21, 2018.
Oil prices spike after producers in OPEC+ announce unexpected cuts.
According to Carl Tannenbaum, chief economist at Northern Trust Corporation, “energy costs are a very important component in people’s predictions of inflation, but right now, they’re not having that hold on consumer psychology.”

It’s a different situation, he continued, “if the price of a gallon of ordinary gasoline gets above $4.”

Nevertheless, John Leer, chief economist at data analytics company Morning Consult, noted that lower consumer spending may have mixed effects on inflation. While it may lessen inflationary pressure for businesses that offer services, it may also raise the likelihood that the US will experience a recession.

“On a practical basis, you would see demand contract that way,” Leer said. “If consumers are allocating a higher share of their wallet to energy bills, that’s going to constrain their ability to spend money elsewhere.”

In the end, oil prices are just too unpredictable to follow, according to James Bullard, president of the Federal Reserve Bank of St. Louis, in an interview with Bloomberg. He acknowledged the potential effects of increasing pricing nonetheless.

He noted that some of that might contribute to inflation and make his work slightly more challenging.