Rising energy costs may squeeze families, but not the economy

• Key takeaway: Working-class families are likely to feel the greatest strain from the inflationary pressures spurred by higher energy prices and President Donald Trump's tariff policies.
• Expert quote: "Uncertainty raises the option value of waiting, and waiting means not spending now. The uncertainty in the Middle East probably is going to delay major purchases, especially durable goods." — Vincent Reinhart, chief economist at BNY Investments
• What's at stake: The war in Iran and its effect on global supply chains, including energy markets, has raised concerns that inflation could begin climbing again in the U.S., complicating the Federal Reserve's path on interest rates and monetary policy. 

WASHINGTON — Rising energy costs tied to the war in Iran are expected to squeeze working-class family budgets, but they are unlikely to tip the U.S. economy into a recession in the near term, experts say.

Much depends on how long the conflict lasts and how quickly the Strait of Hormuz reopens, factors that will help determine how high oil prices climb and how sharply the increases hit consumers and the broader economy.

Higher gasoline prices are an immediate and visceral blow to consumers, but prolonged geopolitical turmoil could ripple through the economy, driving up the cost of goods and services such as airfare and food.

Economists say oil prices would likely need to rise substantially higher before triggering the kind of recessionary chain reaction that slows economic activity. 

"There is no quote-unquote 'breaking point,'" said Adie Tomer, a senior fellow at the Brookings Institution. "The question is: At what price does oil become a drag on the economy and begin triggering pullbacks in spending and economic activity that could push us into a recession?"

Peace talks between the Trump administration and Iran have continued for more than a month without a breakthrough. Oil prices climbed to $104 a barrel amid fears that prolonged fighting could further disrupt global energy supplies and shipping routes. 

Gregory Daco, chief economist at EY-Parthenon, said working-class families are likely to feel the greatest strain from the combination of higher energy prices and President Donald Trump's tariff policies. 

"You think of the tariff shock, and then you layer on top of that an energy price shock, which filters almost immediately to higher prices at the pump and will filter into other costs like food prices over the coming months," said Daco. 

Families with lower incomes are particularly vulnerable because a larger share of their spending goes toward essentials such as energy, food and transportation, he added. But despite mounting price pressures, Daco said households entered the conflict in relatively solid financial shape.

"The reassuring thing is that we're starting from fairly healthy positions when it comes to household balance sheets, so we haven't seen, so far, any significant surge in delinquencies or significant surge in defaults," he said. 

For now, the economy is being buoyed by heavy investment in technology and strong consumer spending. 

Vincent Reinhart, chief economist at BNY Investments, said the economy still has strong "momentum and aggregate demand," fueled by fiscal stimulus and investment in technology, though the energy shock has added "confusion to the mix."

Energy use is essential for most consumers, Reinhart said, meaning higher prices typically do not reduce demand immediately. Instead, consumers tend to cut back on other purchases.

"Uncertainty raises the option value of waiting, and waiting means not spending now," Reinhart said. "The uncertainty in the Middle East probably is going to delay major purchases, especially durable goods."

Reinhart said massive investment in artificial intelligence and related capital spending is helping offset those concerns for now. "The incentive for capital spending right now is so enormous and so disconnected from energy prices that it's overpowering those concerns," he said.

One sign that higher energy prices could begin to threaten economic growth would be sustained stress in financial markets. 

"You could see a tightening of financial conditions, with yields rising and equities falling in a prolonged manner — not just a short term dip and then rebound like we saw over the course of the past couple of months with the Middle East conflict," said Daco.

Another potentially disruptive event would be a sharp rise in oil prices. Some market watchers, including Derek Tang, CEO Of Monetary Policy Analytics, say prices would need to climb into the $150 a barrel range before significantly slowing demand.

"Given the resilience of overall consumption, the high 100s is where we would actually see more demand destruction," he said.

The Iran war also complicates the outlook for inflation and interest rates, potentially making it more difficult for the Federal Reserve's rate-setting committee to chart a path for future rate cuts.

Reinhart, who expects at least one interest rate cut this year, said he believes the current energy shock will pass through the economy without significantly affecting core inflation, noting that it may not be "that big in the longer term perspective." 

Still, he echoed that he would adjust his views if there was a notable tightening of financial conditions.

Daco said the conflict increasingly appears to be shifting from a short-lived disruption into a longer-term event, increasing the likelihood that higher energy costs will ripple through the broader economy.

"That premium is going to be passed on through the goods and services consumers buy, and that will feed into core inflation," Daco said. "The real question is how long this lasts."