Rewritten economic impact of oil prices and inflation

First step: From oil to fuels

Oil prices have surged, with the recent 30 percent climb beginning in late June and continuing to disrupt the inflation-fighting path pursued by governments, central banks, and international institutions. This shift has slowed the anticipated reductions in policy rates, a move closely watched by households with mortgages and by highly indebted businesses who rely on lower borrowing costs.

The latest rise in energy costs has fed into inflation predictions from major authorities, including the Bank of Spain, the European Central Bank, and the US Federal Reserve, though the latter shows a more cautious stance. Both ECB President Christine Lagarde and Fed Chair Jerome Powell have signaled close attention to the evolving energy-price dynamics. With the latest policy communications shaped by higher energy expectations, most analysts now push any rate-cut timing further into the second half of 2024 in the Eurozone and beyond.

From oil to fuels and fuel prices

Brent crude traded near $72 at the end of June, but by the third week of September it hovered around the $94 mark. The rise stems from production cuts agreed by OPEC plus members. A 30 percent price increase translates into higher fuel costs, which have risen consecutively for eleven weeks. The July and August increases — about 11.6 percent for diesel and 7.4 percent for gasoline — were key drivers behind inflation lifting from a nadir of 1.9 percent in June to 2.6 percent in the following month. By early September, the average price of fuel had climbed as much as 16 percent since the start of summer, according to the EU oil bulletin.

These dynamics show how sharp energy-price movements propagate through the economy, affecting transportation costs, consumer prices, and ultimately household budgets across Canada and the United States as well as Europe.

High prices projected to persist into 2025

The energy tension is not expected to ease quickly over the next few years. The Bank of Spain’s new projections for 2023 to 2025 assume Brent crude averaging about $83.8 for 2023, with little change in 2024 and a dip to about $78.8 in 2025. The forecast reflects futures-market pricing and is higher than estimates from June. For 2024 the projection rose by roughly 10.9 dollars compared with June estimates, and by 2025 the long-run estimate rose by about 8.4 dollars.

In a quarterly assessment, the Bank of Spain notes that even with a slowdown in activity, oil prices are expected to remain elevated, reaching roughly 20 percent higher than pre-pandemic levels by the end of the projection window. The report also suggests gasoline prices will follow a similar trend, underscoring the potential for sustained inflationary pressure in the energy component.

Step two: From fuels to CPI

The summer surge in oil prices contributed to a sharper rise in inflation forecasts for 2023, lifting the projected average inflation rate in the harmonized index of consumer prices to about 3.6 percent. This revision also nudged the 2024 inflation forecast higher by around seven tenths, to roughly 4.3 percent, while the central bank envisages 1.8 percent for 2025. The energy-driven upward revision reflects stronger than expected price pressures across energy products and services.

Christine Lagarde, president of the ECB, has highlighted that higher energy costs are a principal factor behind renewed inflation projections for this year and the next. Jerome Powell, the Fed chair, has stressed that policymakers will monitor how sustained energy-price gains translate into higher inflation expectations among consumers. The central banks in Spain, the euro area, and the United States are all weighing the consequences for policy paths, growth, and job markets.

There is ongoing concern among central banks about the transmission of higher energy costs to other sectors. Spain’s central bank and the ECB are examining how increases in energy prices speed up and amplify price growth in a range of goods and services. A common way to describe this transmission is through the acceleration or deceleration of price changes as energy costs move through the economy, influencing prices at service stations and other points along the supply chain.

Step three: From inflation to interest rates

With these pressures in view, monetary authorities remain vigilant. After an upward revision of euro area inflation forecasts, analysts have shifted attention to the second half of 2024 for potential policy actions. Lagarde and the Spanish central bank governor, Pablo Hernández de Cos, have hinted that the recent tenth increase in rates to 4.5 percent could be the last step of the current cycle, yet the ECB has not ruled out another move if energy-price momentum persists. The rise in oil prices remains a central threat, alongside a softening labor market and potential wage pressures that could sustain inflationary dynamics.

As energy inflation has cooled in the past, the current path points to a careful calibration of policy options. The energy component’s persistence raises questions about how central banks calibrate interest rates to balance price stability with growth and employment objectives. The aim remains to manage inflation without triggering a sharp contraction that would hamper the recovery in households and businesses across North America and Europe.

Step four: The inflation narrative and energy costs

After the peak of energy-driven inflation in the summer of 2022, inflation across Europe and Spain retraced toward more moderate levels, aided mainly by easing energy prices. However, energy-price dynamics reversed in August, pushing inflation back up to around 2.6 percent and rekindling concerns about the energy footprint on consumer prices. The Bank of Spain projects energy inflation to reach the mid-20s by March 2024, potentially lifting overall CPI to a peak in the spring of the following year. The central question remains how much this energy-price trajectory will shape policy choices and rate decisions as the outlook evolves across the North American and European economies.