(Yahoo! Finance) - With a two-week ceasefire underway in Iran, oil prices are dropping. If the situation holds, expectations for higher inflation could also drop.
A new analysis from the Dallas Federal Reserve said that if the war ends and the Strait of Hormuz reopens, allowing oil to flow again, inflation expectations should come back down quickly.
The researchers examined how closing the Strait of Hormuz over different time frames could affect the price of West Texas Intermediate crude oil (CL=F) and, by extension, inflation.
If the strait’s closure is limited to one quarter, inflation as measured by the Personal Consumption Expenditures Index would increase by 5.2 percentage points in March and by 3.5 percentage points in April. That increase would be partially reversed in June and July when inflation would drop by more than 2 percentage points each month, after which the effect would be close to zero.
If the closure is over after one quarter, the researchers determined, the effect on “core” inflation, which excludes volatile energy and food prices, would reach 0.8 percentage points at an annualized rate in April but then fluctuate as it diminishes.
One-year inflation expectations would increase by 0.36%, while five-to-10-year inflation expectations would increase by 0.04%, largely unaffected.
However, if the strait were to remain closed for two quarters, inflation would continue to increase by between 1.9 and 2.2 percentage points in June and July, before turning negative in August, September, and October, the study said. Finally, if the closure persists for three quarters, inflation would move higher until October, before turning negative in November, December, and January 2027.
Even with the strait closed for two quarters, one-year inflation expectations rise by 0.54%, while five-to-10-year inflation expectations increase just 0.6%, again largely unaffected.
The strait has been effectively closed for just over a month.
A new survey from the New York Federal Reserve found that consumers now expect prices to climb 3.4% this year, up 0.4% from last month. That’s nearly 1.5% above the Fed’s 2% inflation goal. Fed officials expect inflation of 2.7% this year.
President Trump on Tuesday said he agreed to suspend attacks on Iran for two weeks, subject to the immediate reopening of the Strait of Hormuz. The administration warned that the Pentagon is prepared to resume military attacks if the ceasefire collapses and talks fail.
Already on Wednesday, the complexity of reopening the strait was emerging as a point of disagreement.
Over the past week, a number of Fed officials, including Fed Chair Jerome Powell, have cautioned that they are aware that the oil price shock is occurring at a time when inflation has remained above the central bank’s 2% goal for five years. Some, including St. Louis Fed president Alberto Musalem and Kansas City Fed president Jeff Schmid, have been more direct, cautioning outright about looking through the oil price shock, given that inflation has remained elevated.
