OPEC+ surprise production cut announcement complicates Federal Reserve’s mission to cool economy and worsen US inflation, economists warn

Oil prices surged on Wednesday after Saudi Arabia and several other OPEC+ oil producers announced surprise production cuts, a move that could complicate the Federal Reserve’s efforts to cool the economy and worsen inflation in the United States, according to economists.

Last year, energy prices skyrocketed when Russia invaded Ukraine, contributing to global inflation just as major economies were starting to rebalance after the pandemic. However, a drop in energy prices helped to cool US inflation, which has dropped from a 40-year peak of 9.1% in June to 6% in February, according to the Consumer Price Index.

The announcement of the OPEC+ production cuts could now undermine those efforts. Energy prices, which make up approximately 7.5% of the overall index, were up 5% in February from the same month a year ago, which is well below the 41.3% rise seen in June, according to the Bureau of Labor Statistics.

Fed officials consider multiple economic metrics in order to inform their decision-making, but one of their main focuses is on core inflation, which strips out volatile food and energy prices. However, higher oil prices can eventually push up core prices if they remain elevated for long enough.

According to Sarah House, senior economist at Wells Fargo, while the Fed sees OPEC decisions as mostly geopolitical, they can impact the production of goods and the transportation of other items, so higher oil prices can bleed into the core component, which the Fed tends to focus on more in terms of setting policy.

Moreover, higher energy costs can soften overall demand by weighing on consumer sentiment and consumer spending, both of which were surprisingly robust at the beginning of the year but have recently started to cool.

However, weaker consumer spending could be a mixed bag in terms of inflation, said John Leer, chief economist at data analytics firm Morning Consult. While it can reduce inflationary pressure for service-providing businesses, it can also increase the odds of the United States going into a recession.

Ultimately, the volatility of oil prices makes them difficult to track, according to James Bullard, president of the Federal Reserve Bank of St. Louis, in an interview with Bloomberg. He acknowledged the eventual impact of higher prices, stating that “some of that might feed into inflation and make our job a little bit more difficult.”

While higher oil prices may not be having a hold on consumer psychology yet, Carl Tannenbaum, chief economist at Northern Trust Corporation, warns that if the price of a gallon of regular gasoline goes above $4, then it’s a different story.

For now, economists will continue to monitor the impact of the OPEC+ production cuts on the US economy, with some concerned that the move could worsen inflation and complicate the Fed’s efforts to cool the economy.