Higher Prices, Lower Rates? Powell Explains the $4 Gas Paradox

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Federal Reserve Chair Jerome Powell has signalled that the central bank will likely “look through” the spike in gasoline prices above $4 per gallon rather than raise interest rates to fight it.
Powell argued that by the time a rate hike’s effects take hold, an oil price shock “is probably long gone, and you’re weighing on the economy at a time when it’s not appropriate.”
Investors now see just a 2.1% chance of a rate hike by year-end, with some strategists predicting the Fed may be forced to cut rates as early as September to offset demand destruction from high energy costs.

Gasoline prices above $4 per gallon might seem like a clear signal for the Federal Reserve to raise interest rates and head off inflation, but Chair Jerome Powell has effectively taken that option off the table. In remarks on Monday, Powell argued that raising rates now would be the wrong medicine for an economy already facing a softening labour market and elevated recession risks, noting that by the time monetary tightening takes effect, “the oil price shock is probably long gone.” Investors have pivoted accordingly, with futures markets now pricing just a 2.1% chance of a rate hike by year-end and assigning roughly 25% odds to cuts later in 2026.

The national average for regular unleaded gasoline has eclipsed $4 per gallon, and U.S. crude oil is trading above $102 per barrel, following the effective closure of the Strait of Hormuz for more than a month. But Powell’s comments signal a significant shift in how the Fed responds to supply shocks. “The tendency is to look through any kind of a supply shock,” he said, explaining that hiking rates to fight energy-driven inflation would weigh on the economy at an inappropriate time.

Wall Street economists largely agree. Rob Subbaraman, head of global macro research at Nomura, said “central bankers’ bark will be bigger than their bite” when it comes to fighting higher prices. He argued that while central banks need to sound hawkish to anchor inflation expectations, the pass-through to wage growth and core inflation is likely limited. Instead, the greater risk is that the Middle East war “could quickly morph into a global growth shock.”

Joseph Brusuelas, chief economist at RSM, warned that policymakers should fear “demand destruction” , the economic term for when high prices force people and businesses to spend less, resulting in fewer cars sold, fewer homes bought, fewer restaurant meals, and eventually fewer jobs. “This is the classic stagflation dilemma, and there’s no clean answer,” he said. Carlyle Group strategist Jason Thomas went further, suggesting that if the economy weakens, rate cuts could arrive as soon as September and “in greater than 25 [basis point] increments.”

Meanwhile, the relief for American drivers may be slow to arrive. Even with a temporary two-week ceasefire agreement between the U.S. and Iran, most shipping firms still consider routing tankers through the Strait of Hormuz too risky. Only two oil tankers crossed the strait in the three days following the ceasefire announcement, according to data intelligence firm Kpler. The U.S. Energy Information Administration projects that gas prices could peak near $4.30 per gallon this month and remain elevated, averaging $3.70 per gallon for all of 2026 well above the $3 level before the war broke out.