Federal Reserve research sounded a wake-up call: the transmission effect of oil prices on core inflation increased after the pandemic, and inflation may reach 2.8% in 2027

The Zhitong Finance App learned that a recent study by Federal Reserve researchers found that after the epidemic, the transmission effect of oil prices to core inflation increased markedly, and the sustainability of core inflation itself also rose sharply. If this change continues, the average core inflation rate of developed economies may be close to 2.8% in 2027, which is about 0.6 percentage points higher than the level under the pre-pandemic inflation operating mechanism.

This finding means that even if the energy price shock gradually recedes, its impact on overall prices is likely to last longer than in the past. For the Federal Reserve and other major central banks, the risk of inflation brought about by fluctuations in energy prices may be more difficult to deal with than before the pandemic.

The study examined data from the five developed economies of the United States, Canada, the Eurozone, Japan, and the United Kingdom from 2000 to the second quarter of 2026. The study found that before the epidemic, for every 10 percentage point increase in the oil price inflation rate compared to other price inflation rates, the core inflation rate only increased by about 0.01 percentage points, and this impact was not statistically significant; after the epidemic, the increase in core inflation corresponding to changes in oil price inflation of the same magnitude rose to about 0.14 percentage points, and was statistically significant.

At the same time, the sustainability of core inflation has also increased markedly. Research estimates that the core inflation sustainability coefficient has risen from around 0.35 before the pandemic to about 0.65, which means that the rate at which the impact of inflation subsides may slow down. Incorporating the two changes of the enhanced transmission effect of oil prices and the continued rise in inflation into the model can better explain the trend of inflation. The prediction error is also significantly lower than the model that only considers continuous changes in inflation or makes no adjustments at all.

The researchers further used the Brent crude oil futures price curve up to the beginning of August 2026 to calculate. If the transmission effect of oil prices increases after the pandemic and the trend of continuing to rise in core inflation continues, the average core inflation rate of developed economies may approach 2.8% in 2027; the indicator may only gradually fall back to about 2.2% by the end of 2028.

This result is a scenario estimate based on specific assumptions; it is not the Federal Reserve's official inflation forecast. Researchers also pointed out that post-pandemic statistical results may partially reflect simultaneous changes in oil prices and overall demand pressure, and not entirely as a causal effect caused by the oil price shock itself, so it cannot simply be viewed as a pure effect of changes in oil prices on core inflation.

The study also found that in the structural model, a 10% increase in oil prices caused by a supply shock had an impact on economic output about twice that of before the pandemic. This means that energy supply shocks may push up inflation and cause a greater drag on economic activity, which in turn will cause monetary policy to face more complex trade-offs: central banks may need to adopt tighter policies to deal with inflationary pressure, yet they have to consider the impact on economic growth.

If oil prices fall, will the risk of inflation subside?

The recent marked decline in international oil prices provided a realistic background for this study. As traders increased their bets on the possibility of a resolution of the Middle East war, Brent crude oil futures fell nearly 3% on Tuesday to 89.96 US dollars/barrel, falling below 90 US dollars/barrel for the first time since August; WTI crude oil futures fell more than 2% to 84.63 US dollars/barrel on Tuesday.

The fall in energy prices is also beginning to spread to American consumers. According to the American Automobile Association (AAA), the average retail price of regular gasoline across the US fell to $3.98 per gallon on Monday, falling below the important psychological threshold of $4 for the first time since mid-July. However, at present, gasoline prices in the US are still about 19% higher than the seasonal average, and the pressure on energy costs has not completely subsided.

Since the US and Israel launched military attacks on Iran at the end of February this year, the Strait of Hormuz, a key waterway, has been blocked, disrupting the export and transportation of crude oil and refined oil products, and driving up energy prices sharply. Recently, the situation in the Middle East has shown signs of easing. Trump said on Monday that there seems to be no need to take military action against Iran at the moment, adding that the conflict may end soon. Market hopes for progress in peace negotiations and the restoration of energy supply in the Middle East are heating up.

However, energy supply risks remain. Despite the restoration of ship traffic in the Strait of Hormuz over the past few months, and the total volume of oil transportation in the Middle East is close to pre-war levels, Saudi Arabia's key east-west oil pipeline was attacked on Monday. Meanwhile, Ukraine continues to attack Russian refineries, and Russia is also targeting energy and civil infrastructure.

The researchers pointed out that the impact of the second round of energy price shocks has not yet been clearly evident, but related risks may be accumulating. The fall in oil prices will undoubtedly help ease short-term inflationary pressure, but changes in the inflation transmission mechanism after the pandemic mean that fluctuations in energy prices may still have a more lasting impact on core inflation and monetary policy.