'People will feel that': Fed's Powell says war could fuel inflation

Powell, in testimony to the Senate Banking Committee, said Americans are going to see higher gas prices, while transportation and energy costs will also rise for businesses.

Federal Reserve Chair Jerome Powell on Thursday acknowledged that spiking oil prices triggered by Russia’s invasion of Ukraine could stoke already high inflation, as a top industry executive and analysts warned that the surge could get a lot worse.

Powell, in testimony to the Senate Banking Committee, said Americans are going to see higher gas prices, while transportation and energy costs will also rise for businesses. But he said the extent of the fallout will depend on how long markets continue to have anxieties about the energy supply.

“People will feel that certainly at the gas pump,” Powell told lawmakers, adding that could also bite into spending elsewhere and affect growth. “You would expect at least a little bit of lower economic activity.”

The benchmark U.S. oil price over the past day rose to its highest level since 2008, while global benchmark Brent breached $118 a barrel for the first time since 2013. JPMorgan analysts warned in a note that Brent oil prices could reach as high as $185 a barrel by the end of the year if disruptions to Russian supplies lasted throughout 2022.

Exxon CEO Darren Woods also said prices could go much higher. “If there is a significant supply disruption with respect to Russian crude … that will be very difficult for the market to make up and therefore that will lead to, I think, significantly higher prices,” Woods told CNBC on Thursday. His company this week halted operations in Russia, while Shell and BP have announced that they will divest their assets in the country.

Oil prices are the biggest foreseeable risk for the U.S. economy from Russia’s attack on its neighbor because Russia is one of the world’s biggest energy suppliers. But whether that will simply add to prices in the short term or be a more lasting accelerant of inflation will depend both on how high prices go and how long the shock to prices lasts, Powell said.

“You can have an oil spike and if it just comes and goes, prices will go up, but it won’t actually affect ongoing inflation,” the Fed chief said.

“The concern, though, is there’s already a lot of upward inflation pressure, and additional inflation pressure does probably raise at the margin the risk that inflation expectations will start to react in a way that is negative for controlling inflation,” he added.

It’s too soon to tell whether this all might lead to a change in course for the central bank, which was already planning to start a campaign of interest rate hikes later this month because inflation has reached a four-decade high.

Powell, who has held his job on an acting basis since February while he awaits confirmation to a second term, was pressed by multiple senators on the economic implications of the Ukraine conflict. Sen. Steve Daines (R-Mont.) said lawmakers were “very very concerned, certainly as you are, of where this might go.”

The Fed chief said there’s a lot of uncertainty around how long the conflict will last and how the U.S. and its allies will respond. So far, Western economies have avoided directly sanctioning Russian energy but have never completely taken that option off the table. Calls in Congress for the U.S. to ban Russian oil imports have risen.

Powell said a rough rule of thumb is that a $10 increase in the price of a barrel of oil leads to a 0.2 percent increase in inflation and a 0.1 percent hit to growth.

The question is how high oil prices can go before that starts driving down demand because it’s too expensive. Meanwhile, supply could increase with U.S. companies ramping up production. Investors have also been closely watching for news on a nuclear agreement with Iran, which could end sanctions on that country’s oil exports and fill some of the supply shortfall.

“In the immediate term, so large is the supply shock that we believe price needs to increase to $120 [a barrel] and stay there for months to incentivize demand destruction, assuming no immediate Iranian volumes,” according to the JPMorgan research note.