Fed’s Musalem said oil prices from the Iran war could keep core inflation near 3% this year, likely forcing the Fed to hold rates for longer as supply shocks lift costs and growth slows.

Summary:

  • St. Louis Fed President Alberto Musalem said high oil prices are likely to keep core inflation near 3% this year, above the Fed’s 2% target.
  • The Fed is likely to keep rates on hold for some time as it assesses the inflation and growth outlook.
  • The Iran war and resulting oil shock are key drivers, alongside tariffs and immigration constraints as supply-side pressures.
  • Musalem flagged risks on both sides of the Fed’s mandate: persistent inflation and a slowing labour market.
  • He said rate hikes remain possible if inflation expectations begin to de-anchor.
  • US growth is expected to slow to around 1.5%–2% in 2026.

Federal Reserve Bank of St. Louis President Alberto Musalem said elevated oil prices driven by the Middle East conflict are likely to keep underlying US inflation near 3% this year, complicating the Federal Reserve’s policy outlook and reinforcing the case for holding interest rates steady.

Speaking in an interview with Reuters, Musalem said the recent surge in energy costs is expected to pass through into broader price pressures, keeping core inflation (inflation stripped of volatile food and energy components) well above the Fed’s 2% target. He indicated that core inflation could end the year “around 3%,” with risks skewed to the upside.

This backdrop, he suggested, supports maintaining the current policy rate in the 3.50%–3.75% range for an extended period, as officials monitor incoming data on inflation, employment and economic activity. The Fed had previously been expected to begin cutting rates in 2026, but the oil shock linked to the Iran war has shifted expectations toward a prolonged pause.

Musalem characterised the current environment as shaped by multiple supply-side shocks, including higher oil prices, tariffs and tighter immigration policy, all of which are exerting upward pressure on costs while weighing on growth. He expects economic expansion to slow to between 1.5% and 2% this year.

While some disinflationary forces remain in place—such as easing housing price pressures and fading tariff effects—Musalem warned that inflation risks remain balanced but elevated. He emphasised that policymakers must ensure all components of inflation move lower in a sustained and balanced way, noting that services inflation remains particularly sticky.

Crucially, he left the door open to further tightening if inflation expectations begin to drift higher, warning that the risk of de-anchoring expectations would warrant a policy response. At the same time, he acknowledged that a weakening labour market could justify rate cuts, underscoring the Fed’s increasingly complex policy trade-off.

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Reinforces a “higher for longer” rates narrative, with oil-driven inflation limiting near-term easing. Front-end yields may stay supported, while markets reassess timing of cuts amid persistent inflation risks and slower growth.

This article was written by Eamonn Sheridan at investinglive.com.

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