Americans’ expectations for inflation will shape Fed’s response to Iran war, Powell says

By Bryan Mena, CNN

Washington (CNN) — The Federal Reserve’s response to the US-Israeli war on Iran largely hinges on how the conflict affects Americans’ expectations about inflation, Chair Jerome Powell said Monday.

“The tendency is to look through any kind of a supply shock,” he said during a moderated conversation hosted by Harvard University. “But a critical, essential aspect of that is you have to carefully monitor inflation expectations.”

The Fed chief also hinted at keeping interest rates unchanged in the short term, looking through the ongoing global energy price shock: “Monetary policy works with long and variable lags, famously, and so, by the time the effects of a tightening in monetary policy takes effect, the oil price shock is probably long gone,” he said.

Powell’s latest remarks come as the Iran war stretches into its fifth week, with President Donald Trump threatening to destroy the country’s energy infrastructure if a deal isn’t reached to end the conflict and reopen the Strait of Hormuz, a major global chokepoint that handles one-fifth of the world’s oil supply, along with many other commodities.

Oil prices rose Monday after Trump’s comments: Brent crude, the global benchmark, climbed past $116 a barrel earlier in the day, before paring back those gains. Gas prices across America have already surged over the past month. The blockade has also jacked up plastic and fertilizer prices.

Americans have taken note, with consumer sentiment declining 6% this month to its lowest point since December, according to the University of Michigan’s latest consumer survey. People’s inflation expectations in the year ahead have shot higher, the survey indicated, however, longer-run expectations have remained in check.

Fed officials focus more on long-run expectations, in the next five to 10 years, which serve as a proxy for Americans’ confidence in the Fed’s ability to rein in price increases. However, that could take a turn for the worse if the Iran war drags on for months.

Just a week and a half ago, Fed officials penciled in one rate cut this year when they updated their economic projections. Now, Wall Street forecasters are increasingly expecting a rate hike as the conflict with Iran drags on.

The US economy is suffering its fifth consecutive year of elevated inflation, and the Iran war is threatening to push it even higher.

The conflict in the Middle East has thrown the Fed into an extraordinarily difficult situation: Central bank policymakers are not only facing a global price shock, but they’re also contending with a US labor market that’s still in a precarious state. Higher energy costs themselves, if sustained, could also eventually take a toll on economic growth and hiring.

That means Fed officials will have to determine which problem to address first — higher inflation or a weakening labor market.

Powell said earlier this month after officials voted to hold borrowing costs steady for the second-straight meeting that “we just don’t know” how everything will ultimately play out. The war’s economic impact depends on its duration and breadth, economists say.

“No one has been able to successfully predict the economy,” Powell said at the Harvard event.

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