Price of oil and Inflation: It’s complicated
First Order Effect: Higher Inflation
The crisis in the Middle East has pushed oil prices higher, and the dominant narrative is that this could reignite inflation. This is the so-called first-order, or direct, effect. Transportation accounts for roughly 15% of the CPI basket in the US. Oil prices are up more than 50% since the end of February. Consequently, inflation is likely to move higher in the short term. The key questions are: by how much, and for how long?
One way to approach this is through the 5-year breakeven inflation rate, as published by the St. Louis Federal Reserve.
We have used this chart before, but it is worth briefly revisiting what it represents. The 5-year breakeven rate reflects the market’s implied average annual inflation over the next five years. This figure is derived from Treasury Inflation-Protected Securities (TIPS).
Since 27 February 2026, the 5-year breakeven has increased from 2.4% to 2.56% as of 27 March 2026. While oil prices have risen by more than 50%, the market is implying only a modest increase in inflation of around 0.16 percentage points per year over the next five years. That could change, but after a month of elevated tensions, the move remains relatively contained.
It is also worth noting that current levels are not unusual. The 5-year breakeven stood at 2.6% on 27 March 2025, compared to 2.56% on 27 March 2026 — effectively unchanged year-on-year.
Second Order Effect: Delayed Consumption and Higher Savings Rate
While consumers are sensitive to all price increases, gasoline prices tend to have a disproportionate impact — beyond what would be expected purely from reduced purchasing power.
One reason is visibility. Consumers see fuel prices daily, and the increase is reinforced repeatedly. In contrast, electricity costs, while economically similar, are less salient and are typically paid with a lag. Higher fuel costs, by comparison, affect household budgets immediately.
Historically, this decline in consumer confidence has led to delayed consumption, particularly for big-ticket items, as well as reduced investment and a higher savings rate. These effects are, in aggregate, disinflationary.
Conclusion
In the short term, sharp increases in oil prices are clearly inflationary. Over a longer horizon, however, the effects are more nuanced. While the direct impact pushes inflation higher, the secondary effects — through weaker demand and more cautious consumer behavior — can act in the opposite direction.
This distinction is important, especially as current narratives focus heavily on the inflationary implications and the potential for central banks to respond with tighter policy. That outcome is certainly possible. However, at this stage, it is too early to draw firm conclusions.
For now, it will be important to monitor consumer confidence and labor market data to assess whether second-order effects begin to dominate.