US inflation eases to 3.5% as oil spike stalls Fed rate cuts
A drop in US inflation to 3.5% is likely to be temporary after Middle East tensions pushed Brent crude above $87, keeping pressure on the Federal Reserve to maintain or raise interest rates and threatening global trade flows.
US consumer prices rose 3.5% in the year to June, down from 4.2% in May. The decrease was driven by a 9.7% drop in gasoline prices, according to the Bureau of Labor Statistics.
However, the reprieve is already fading. Fresh US military strikes on Iran and President Donald Trump's imposition of a naval blockade and a 20% cargo charge on ships using the Strait of Hormuz have disrupted global trade.
The escalation sent Brent crude surging by almost $10 in 24 hours to hit $87 on Tuesday. For Europe, which relies heavily on this global oil benchmark, the spike signals a renewed threat to the continent's own inflation trajectory.
The shifting energy landscape complicates the mandate of newly appointed Federal Reserve chairman Kevin Warsh. Speaking ahead of his first address to the US Congress, Warsh emphasised his committee had "no tolerance to persistently elevated inflation."
"We share a resolute commitment to restoring price stability," he said in prepared comments. The Fed held US rates between 3.5% and 3.75% at Warsh's first meeting in June. While Trump has demanded borrowing cost reductions, analysts warn the central bank is instead moving toward a tighter stance.
Federal Reserve governor Christopher Waller warned that if core inflation remains elevated, the FOMC "will need to consider tightening monetary policy in the near term." He told the New York Association for Business Economics that "sternly staring at inflation until it melts before our withering gaze is not an option."
Markets are adjusting to the reality that rate cuts are unlikely. "Gasoline prices are already back above June levels, meaning the next inflation report will heat up again," said Ipek Ozkardeskaya, senior analyst at Swissquote Bank.
Lindsay James, investment strategist at Quilter, noted that despite getting his "feet under the table," Warsh is unlikely to cut rates to appease the White House. "Instead, we are likely to see a conservative outlook from the Federal Reserve when it meets in a fortnight," she added.
Beneath the volatile energy figures, underlying price pressures in the US remain stubborn. Core inflation, which excludes food and energy, held steady at 2.6% in June. Food prices increased, with the cost of meat, dairy and cereals rising, while eating out cost 3.7% more than a year ago.
The persistent cost pressures are taking a toll on the real economy. More than a fifth of small business owners now cite inflation as their "single most important" problem, the highest share in almost two years, according to the National Federation of Independent Business.
A Fed forced to keep rates high to combat imported energy shocks will keep global financing conditions tight. For European investors and exporters, a sustained period of elevated US rates and $87 oil presents a dual headwind to growth.
