Inflation hits expected near-term bottom; Middle East war to soon hit prices

A key measure of inflation recorded its smallest rise in almost five years in February, though the slowdown in price growth will likely be extremely short-lived due to the ongoing conflict in Iran.

The consumer price index (CPI), the market's preferred inflation measure, increased 2.43% from February 2025 to February 2026, the smallest annual increase since April 2025. Core CPI, which strips out volatile food and energy prices, rose 2.47%, the smallest year-over-year increase since March 2021.

However, with retail gasoline prices surging due to the war and ongoing threats to global flows of crude oil and other commodities, US headline inflation annual growth stands to rise above 3% in the second quarter and may stay there until the end of 2026, according to James Knightley, chief international economist at ING. Energy prices could keep inflation growth above the Federal Reserve's 2% target until the second half of 2027.

"The longer energy costs stay elevated, the greater the risk it becomes demand destructive, which dampens core inflation pressures over the medium to longer term," Knightley said in an email.

Energy prices may make headline CPI "jump dramatically," said David Russell, global head of market strategy at TradeStation. Core inflation may not see as significant of an increase as relatively slower moving categories like shelter and automobiles are moderating, and investors may ultimately look past higher energy prices if they view them as short-lived, Russell said in an interview.

"The key question isn't how high energy prices go, but how long they stay high," Russell said.

The new conflict in the Middle East has upended inflation expectations and could impact the Fed's interest rate plans, though it is too early to predict how, according to Oren Klachkin, a financial markets economist with Nationwide.

"The rapid news flow is leading us to revisit our inflation forecasts almost on a minute-by-minute basis," Klachkin said. "Right now, we see clear upside risks to inflation, and it's not just from energy."

Food prices and other goods and services are at risk of significant increases in the coming months, along with energy, Klachkin said. The Fed is highly unlikely to cut rates at its meeting next week, but the central bank will likely continue to monitor the conflict duration and scope.

"That said, right now it's not trending in an encouraging direction from the economic perspective," Klachkin said. "Markets are coming around to the view the conflict will last longer than they initially thought, but I think there's more re-pricing to do."