According to Federal Reserve researchers, the impact of rising oil prices on core inflation in advanced economies is now more significant and enduring compared to the pre-pandemic era. The study anticipates that if current trends persist, the average core inflation across five major economies could reach 2.8% by mid-2027.
Oil’s Amplified Inflationary Effect
The research, conducted by Andrea De Michelis, Musa Orak, Avani Pradhan, and Albert Queralto, analyzes data from the U.S., Canada, the Eurozone, Japan, and the United Kingdom spanning from the first quarter of 2000 to the second quarter of 2026. The study examines how Brent crude oil prices influence core inflation—a measure excluding volatile items—while accounting for supply chain disruptions and economic activity trends.
Prior to the pandemic, oil prices had a negligible impact on core inflation. However, the researchers discovered that since early 2021, this impact has become statistically significant. Concurrently, the pass-through of inflation from one quarter to the next, an indicator reflecting inflation persistence, rose from 0.35 to 0.65.
Illustrating this shift, researchers explored a scenario where oil prices permanently increase by 10%. Under pre-pandemic conditions, the core inflation index would increase by 0.05% over three years. In contrast, post-pandemic scenarios project a 0.35% rise, predominantly occurring within the first two years.
Forecasting Mid-2027 Inflation
To estimate the effects of a 2026 oil price increase, the research leveraged early August Brent futures prices and assumed that supply chain pressures would gradually diminish. Base calculations suggested annual core inflation could peak around 2.2%. When accounting for longer-lasting inflation effects, the estimate rises to approximately 2.5%. Adding in the heightened influence of oil prices, core inflation could approach 2.8% by mid-2027, before potentially settling back to 2.2% by the end of 2028.
The authors regard this figure as an upper limit, contingent on the sustained impact of both pandemic-related economic recovery and supply chain issues. Other factors such as heightened demand, governmental support measures, and supply chain interruptions have compounded price fluctuations. Thus, the effect of an isolated oil shock might be relatively constrained.
An alternate model within the study examines a scenario where a 10% increase in oil prices stems from a supply shortage. Should inflation become more persistent, coupled with a stronger pass-through of oil costs, economic losses compared to pre-pandemic conditions could double. Central banks, grappling with slowing economies, would face the dilemma of hiking interest rates further to rein in inflation. Higher costs would stifle production, while expensive energy and tight monetary policy could suppress spending.
Both the European Central Bank and the Bank of England have observed relatively stable core inflation indicators, notwithstanding rising upside risks. According to Fed researchers, prolonged oil price hikes in the futures market or extended supply chain disruptions could amplify this risk’s impact on core prices.
If oil prices remain elevated and slow the decline in core inflation, central banks may maintain high-interest rates longer. Such a scenario could make lower-risk instruments, like short-term government bonds, more appealing due to their interest yields. Consequently, risk aversion may weaken demand for Bitcoin and other cryptocurrencies, exerting downward pressure on their prices.
