Oxford Economics: Sustained high oil prices could cause the U.S. economy to "stagnate" in the long term

Why is the critical point for oil prices set at $140 per barrel?

If oil prices remain high for an extended period, President Donald Trump will face multiple risks. Image source: Heather Diehl/Getty Images

The global energy crisis triggered by the war in Iran has caused market turbulence and pushed oil prices to their highest levels in four years. As the conflict escalates, the likelihood of a swift resolution is declining, and the hope that the U.S. economy can remain insulated is becoming increasingly bleak.

This war has effectively blocked the Strait of Hormuz, a crucial energy passage connecting oil-producing countries in the Persian Gulf to global markets. According to the International Energy Agency, the blockade has disrupted the transport of approximately 20 million barrels of crude oil daily through the strait. The IEA estimates that this conflict has resulted in a reduction of about 8 million barrels in global daily supply, marking the most severe oil supply crisis in history. As a result, oil prices have fluctuated dramatically. The international benchmark Brent crude was around $70 per barrel before the war and approached $120 last week, subsequently retreating to a range of $90 to $100.

The fluctuation in oil prices has already driven up gasoline prices in the U.S., but this may not be sufficient to trigger the severe economic recession warned by some economists. A report released last Friday by the consulting firm Oxford Economics indicated that, in the long run, the current price level might have a negligible impact on economic output.

However, this assessment is based on the premise that oil prices can quickly return to pre-war levels in the coming months. The longer the blockade of the Strait of Hormuz lasts and the higher oil prices rise, the faster the global economy, including that of the U.S., will deteriorate.

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The economic pressure threshold

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Oxford Economics uses a conventional empirical rule of thumb to estimate the impact of rising oil prices on the economy: if oil prices continue to rise by $10 (for about two months), due to increased inflation and slowing economic growth, GDP will decline by 0.1%. The report states that if oil prices average $100 per barrel over two months, global GDP growth will decline by a few tenths of a percentage point, but a recession may still be avoided.

Oxford Economics believes that the “critical point” for the economy hinges on whether oil prices will average around $140 per barrel over two months. Once this level is reached, the spillover effects will become more difficult to control, and many regions worldwide will face the risk of economic downturn.

The report’s authors wrote: “The Eurozone, the UK, and Japan will experience mild contractions, while the U.S. economy will be close to a temporary stagnation, and a wave of layoffs will push the unemployment rate close to recession territory.”

The difficulty in calculating the economic consequences of high oil prices lies in their “exponential” amplification effect. The larger the increase in oil prices, the more chain reactions occur in the economy. Persistently high oil prices and transportation costs will gradually transmit to the food and other goods sectors, causing inflation to evolve from being primarily concentrated in fuel and energy to becoming a widespread issue. If the market broadly believes that oil prices will remain high for an extended period, the Federal Reserve and other central banks will lean more towards tightening interest rate policies, thereby curbing economic activity.

The last complicated factor is the psychological aspect. The report notes that if oil prices remain high, once consumer expectations of high prices become entrenched, it could lead to a “deterioration of collective mindset.” In car-dependent America, consumers are particularly sensitive to gasoline prices; rising fuel prices will squeeze household disposable income and reduce spending in other areas, further exacerbating the economic slowdown.

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Uncertain outcomes

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According to models from Oxford Economics, in the worst-case scenario, U.S. inflation could rise from the current 2.4% to around 5% by the second quarter of 2026, marking the highest level since March 2023. This level of inflation is likely to prompt the Federal Reserve to adopt a more hawkish stance and may lean towards raising interest rates this year. Although the Fed is likely to keep rates unchanged this week, the Iran conflict has led many forecasters to believe that there will be no rate cuts this year.

While a scenario of $140 per barrel serves as a serious warning, Oxford Economics points out that the probability of this outcome occurring is still relatively low. The report’s authors believe a more likely scenario is oil prices averaging around $100 per barrel, which aligns with the price levels observed for most of the past few weeks. The final trajectory will largely depend on when the conflict calms down and when the Strait of Hormuz can be safely reopened for the export of oil and gas from the Gulf region. Officials from the Trump administration have recently indicated that hostilities may take weeks to ease.

On Monday, after the U.S. announced a series of supply-increasing measures, oil prices retreated. These measures include temporarily easing sanctions on Russian oil exports, allowing Iranian tankers to leave the Gulf, and President Trump calling on other countries to help maintain security in the strait. Additionally, the 400 million barrels of global emergency oil reserves coordinated by the International Energy Agency have provided a limited buffer for the market, helping to alleviate market anxiety.

However, during this conflict, oil prices have already adapted to significant volatility. As the conflict entered its second week, Trump stated on Truth Social that high oil prices are “a small price to pay” to achieve U.S. goals in Iran, leading to a 25% overnight surge in oil prices, approaching $120 per barrel, although they retreated later that week. (Wealth Chinese Network)

Translator: Liu Jinlong

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