Ukraine war will increase US inflation, and oil sanctions could make it much worse

Gas prices were advertised at over $6 a gallon on Monday in Beverly Hills, Calif.Marcio Jose Sanchez/Associated Press

WASHINGTON — The economic impact of the Ukraine war is hitting inflation-weary Americans where they are the most vulnerable and observant: the gas pump.

Oil prices have skyrocketed as buyers on the global market fear Russian oil will stop flowing to the West, either through additional sanctions or Russian retaliation to them. Even though neither side has moved to cut off the oil, higher prices have already reached gas stations across the United States, where they are adding to inflation that already was running at its highest level in decades.

President Biden promised in his State of the Union address Tuesday night that getting the “rising cost of food, gas, housing, and so much more” under control is his top priority as the economic hit to families in recent months has driven down his approval rating. But even before the war, administration and Federal Reserve officials were struggling to counter an unexpected surge in consumer prices as the world haltingly emerges from the pandemic.

Now, a crisis triggered by Russia, the world’s third largest oil producer, makes forecasting and tackling inflation even more complicated.

“The economic effects of these events are highly uncertain,” Fed Chairman Jerome Powell told members of a House committee eager for clarity Wednesday. “So far, we’ve seen energy prices move up further and those increases will move through the economy. . . . The thing is, we can’t know how large or persistent those effects will be. That simply depends on events to come.”

For the time being, Powell said he anticipated the central bank would go ahead this month with the first in a series of small hikes in its benchmark interest rate to try to tamp down inflation. But he acknowledged “we need to move carefully” to avoid stalling the recovery. Powell said that the US economy was “very strong,” despite the hardship created by high prices, and that the Omicron variant appears to have been just a small speed bump in the recovery.

Economic growth had been expected to slow from its robust 5.7 percent pace last year, the best since 1984. Now, the Ukraine war will slow it even more, economists predicted, because of sweeping sanctions put in place by the United States and its allies. The impact is expected to be more pronounced in Europe, which is more closely tied to Russia’s economy.

Mark Zandi, chief economist at Moody’s Analytics, an economics research and consulting firm, said he’s reduced his 2022 US growth forecast to 3.5 percent from 3.7 percent after the Russian invasion. He’s also anticipating higher oil prices will cause the consumer price index to increase by 5.9 percent this year, half a percentage point higher than he forecast before the war. Consumer prices were up 7.5 percent in January compared to a year earlier, the fastest pace since 1982.

Oil prices are the wild card for the economy, Zandi said. If the United States and its allies stop importing oil from Russia, or if Russian President Vladimir Putin halts exports to punish those nations for sanctions, the economic hit will get much worse.

A barrel of oil, which jumped as high as $112 on Wednesday by one key measure, could vault to $150 in that scenario, Zandi said. That would cause the average gas price nationwide to shoot close to $5 a gallon and the risk of a US recession to rise with it because the Fed would have to hike interest rates more aggressively.

Gas prices on Wednesday averaged $3.66 for a gallon of regular unleaded, up 12 cents in a week and 93 cents in a year, according to AAA. Gas prices are a key factor in inflation, not just for what consumers pay at the pump but for increased shipping costs for other products. A rise in gas prices also tends to spook people even more than other cost hikes, which can cause them to cut back on their spending.

“It gets very scary, very fast,” Zandi said of the psychology of inflation. “Gasoline plays this outsized role in people’s thinking, in how they view inflation and where it’s headed. It’s the price everyone knows. They see it every day and they feel it viscerally.”

Cecilia Rouse, chair of the White House Council of Economic Advisers, told a Washington forum this week that the war in Ukraine “has definitely clouded the outlook” for the US economy, with the biggest concern being the potential impact on oil prices.

The White House has tried to mitigate that by, so far at least, declining to halt imports of Russian oil. And on Tuesday, the United States and 30 other countries announced they were releasing an initial 60 million barrels of oil from their strategic reserves — half of it from the American stockpile of nearly 600 million barrels.

Biden said in his State of the Union address Tuesday night that the release of oil reserves “will help blunt gas prices here at home.”

“I’m taking robust action to make sure the pain of our sanctions is targeted at the Russian economy and that we use every tool at our disposal to protect American businesses and consumers,” he said.

Given the volatility of the oil market, it’s difficult to determine the effect of the release on prices, said Sasha Mackler, who leads the Energy Project at the Bipartisan Policy Center think tank in Washington. But the move was designed to reassure the markets that the United States and its allies are prepared to step in if there’s a sudden drop in oil supply.

The United States, which is second only to Saudi Arabia in oil production, doesn’t need Russian oil, Mackler said. But halting imports from Russia still would drive up prices here. Companies and nations buy and sell oil in a global market, making it impossible to be insulated from worldwide supply and demand.

“Even if we are quote unquote energy independent in the sense that we produce as much as we ultimately consume, we are still exporting oil into the global market and importing oil . . . and there is one price of oil,” he said. “We’re impacted economically no matter where the oil is coming from.”

Higher oil prices could lead to more production, as US companies and other nations pump more to cash in, Mackler said. That would help push prices down over time. For now, though, he said one thing is clear: “Energy prices are going up.”

Americans might be OK with that, at least in the short term. A Morning Consult poll taken the day of the invasion found 46 percent of registered voters said the United States should sanction Russia even if it causes the price of goods here to rise. That compared to 30 percent who said sanctions should only be imposed if they would not cause higher prices and 7 percent who opposed any sanctions.

For each increase of $10 for a barrel of oil, US gas prices rise by about 30 cents, Zandi said. Absent a huge hike in the price of oil caused by a Russian supply cutoff, the overall cost to the US economy — though not to individual consumers — would probably even out because the higher prices paid by motorists would be offset by increased revenue to oil companies, he said.

Diane Swonk, chief economist at the accounting and advisory firm Grant Thornton, agreed that the higher prices aren’t likely to reduce demand significantly in a strong economy. But she noted they would ratchet up inflation, and that’s a problem given its already high level and the oversized impact gas prices have on Americans.

“The economy is pretty resilient right now and I don’t think we’re going to get as much of a demand shock as we might from higher energy prices,” she said. “But we are going to get the inflation part of it because we are adding fuel to a well-kindled fire.”