The price of oil and inflation are positively – and highly – correlated. In other words, as oil prices increase or decrease, inflation moves in the same direction. This is because oil is a major input in the U.S. economy: It is used for essential activities like the transportation of goods, gasoline for cars, and heating homes.
For more on this, see highlights of my report below, followed by a link to the full U.S. Outlook, delivered on May 18.
- The positive relationship between oil prices and inflation is evident in the time period from 2004 to the present, with a significant positive correlation of 0.78.
- The Federal Reserve estimates that of the 13.1% increase in the price of Brent crude from January 5 to May 11, 7.3 percentage points are the result of changing supply and demand factors, with the remainder coming from changes in the value of the U.S. dollar and the risk premium.
- The U.S. withdrawal from the Iran nuclear deal has increased the geopolitical risk premium for oil and stoked additional global oil supply concerns.
- If tensions escalate in the Middle East and there is a sharp and sustained rise in oil prices and inflation, there is a rising possibility for additional rate hikes.
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