Inflation and oil prices widen split over Fed policy

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Fed outlook divides economists

Highlights

Economists expect a 25-basis-point cut in the third quarter of 2027.
Markets see a possible rate increase as early as September.
Core inflation remains elevated at 3.4%.
Oil near $100 adds to the risk of renewed price pressure.

According to a Bloomberg survey of 80 economists conducted from July 17 to 22, forecasters expect the Fed to lower its benchmark rate by 25 basis points in the third quarter of 2027. That is one quarter later than projected in June but remains sharply at odds with financial markets, where traders are pricing in the possibility of a rate increase as early as September.

Inflation keeps the debate open

The divide has widened as inflation remains well above the Fed’s 2% objective. Core personal consumption expenditures inflation, which excludes volatile food and energy prices, stood at 3.4% in May, up from 3.3% in April. The Bloomberg survey also projects a 3.4% annual increase in the second quarter, slightly higher than economists expected a month earlier.

Several Fed officials have warned that another increase could become necessary if inflation proves persistent. At the central bank’s June meeting, nine of 19 policymakers indicated that higher rates could be appropriate in 2026, while eight expected no change and only one favored a quarter-point reduction.

The Fed’s July monetary policy report said inflation had risen during the year and remained elevated, partly because of supply shocks affecting energy and other sectors. That assessment has strengthened the case for keeping policy restrictive until officials see clearer evidence that price pressures are easing.

Oil adds a new complication

Renewed fighting involving Iran has pushed Brent crude back toward $100 a barrel, threatening to reverse recent relief in consumer prices. Higher energy costs can spread through gasoline, transportation, food, and manufactured goods, making it harder for the Fed to distinguish temporary price increases from lasting inflation.

Economists nevertheless expect headline inflation to slow more quickly during the second half of the year. Their rate-cut forecast appears to assume that weaker demand and easing underlying pressures will eventually outweigh the latest energy shock.

A wider gap between forecasts and markets

The disagreement matters because interest-rate expectations influence Treasury yields, mortgages, corporate borrowing, and stock valuations. A delayed cut would keep financing costs elevated well into 2027, while an unexpected increase could further strain households and businesses.

For now, economists are betting that inflation will gradually ease. Markets are placing greater weight on the risk that energy prices and persistent underlying inflation will force the Fed to tighten again.

We have previously highlighted that ECB holds rates at 2.25% as oil raises inflation risks.

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