With a cautious eye on oil prices, Fed likely to hold rates next week following February's inflation reading

The Iran war is expected to push headline inflation higher, mainly due to pressure on oil prices. But the “core” Consumer Price Index (CPI), which strips out the volatility in food and energy categories, showed inflation moving toward the Federal Reserve’s 2% goal, according to February’s print released Wednesday.

Still, Fed officials are likely to remain cautious amid uncertainty around oil price swings emanating from the Middle East.

“Recent increases in energy prices were not fully reflected in this report and may lift headline inflation in coming months,” said Gargi Chaudhuri, chief investment and portfolio strategist of Americas at BlackRock. “The pass-through to core inflation and broader economic growth is likely to be more limited…energy volatility does not signal a return to broad-based inflation pressures.”

Read more: February CPI breakdown: Inflation steadies, but consumers brace for energy fallout

The Consumer Price Index rose 0.2% month over month on a “core” basis in February and 2.5% from a year ago, holding the same level as January.

“In the context of the surge in oil prices, the Fed will still be relieved to see that inflation pressures in most categories seem to be under control,” said Stephen Brown, deputy chief North America economist for Capital Economics.

The upshot: Analysts expect the Fed to hold interest rates steady in their meeting next week and in the near term, as the central bank watches oil prices and the impact of the spike on inflation and the economy.

It’s the core inflation measure that Fed officials pay the closest attention to because it reflects sustained price trends, excluding food and energy prices that can fluctuate quickly and skew short-term inflation assessments.

PCE near 3%?

While Fed officials keep tabs on CPI, their preferred inflation gauge is the Personal Consumption Expenditures index (PCE), which is due out Friday.

PCE has been running hotter than CPI, and analysts are forecasting that PCE on a “core” basis could clock in roughly half a percentage point higher — putting it around 3% — the same level as in December.

Capital Economics’ Stephen Brown expects core PCE inflation to rise 3.1%, compared with 2.5% for CPI. Krishna Guha, head of economics and global central banking strategy at Evercore ISI, anticipates core PCE at 2.9%.

“We think it would take materially more by way of persistently elevated core PCE services inflation that flags risk of second-round effects from tariffs/oil to shift the Fed debate more substantially,” Guha wrote in a note on Wednesday. “The Fed is in no rush and can wait to check.”

While a spike in oil prices could push up headline inflation, a corresponding increase in gas prices could clip consumer spending at the edges. Nationally, gas prices are averaging $3.58 per gallon, according to AAA, up from $2.94 a month ago.

Read more: How oil price shocks ripple through your wallet, from gas to groceries

The Fed is currently in a quiet period ahead of its policy meeting next week. Inflation has held above the central bank’s 2% goal for more than five years, and policymakers are now faced with an oil price surge, while the job market, which had shown signs of stabilizing, appears wobbly again after a surprisingly weak February jobs report.

San Francisco Fed president Mary Daly said those pressures present risks to both sides of the Fed’s mandate — inflation and the health of the job market — similar to last year.

Last week, some Fed officials said the war in Iran could impact the near-term inflation outlook and add to economic uncertainty, potentially pushing back the timeline for any further interest rate cuts under consideration until later this year.

New York Fed president John Williams was one who said the war in Iran is “something that would obviously affect kind of a nearer-term inflation outlook. We’ll have to see how persistent this is and how long this is, but it would have an effect on overall inflation.”

Boston Fed president Susan Collins also said this week that the conflict in Iran exacerbates what she sees as a considerably uncertain economic outlook. While she sees a still-uncertain inflation picture with continued upside risks, Collins said she still thinks inflation will decline again later this year as effects from tariffs fade.

EY-Parthenon chief economist Gregory Daco said he expects the central bank to hold rates steady next week and that Fed Chair Jay Powell and most of the committee will favor caution and patience, arguing rates are not overly restrictive.

However, Fed Governors Stephen Miran, Chris Waller, and Michelle Bowman, who have been concerned about the job market, could show more concern about the jobs side after the latest weak jobs report and look to cut.

“We continue to expect a further cooling in labor market momentum, with upward pressure on the unemployment rate. With CPI inflation still expected to ease toward 2.5% in the second half of the year, the window for further rate cuts will remain open,” Daco wrote in a client note. “But, in an environment where inflation runs above 2% for an extended period, it is entirely plausible that the Fed delivers no rate cuts in 2026.”

Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.

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