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Citi commodity strategists expressed concerns over potential downside risks for oil prices and their subsequent impact on the U.S. Consumer Price Index (CPI).
"Our outlook is for Brent to fall to $60 by 2H’25, down 20% from recent $75 levels," strategist Eric Lee said in a client note.
According to their analysis, a 10% decline in crude oil could translate to approximately a 0.15 percentage point (pp) decrease in U.S. headline CPI, factoring in the pass-through into gasoline prices and its share in the CPI.
Citi notes that crude oil prices, which constitute around 80% of wholesale gasoline and about 50% of retail gasoline costs, do not move in direct proportion to retail gasoline due to refinery and retail margins, as well as taxes. The firm outlines that retail gasoline accounts for roughly 3% of the U.S. headline CPI, with the total energy sector contributing about 6%. Food makes up approximately 14% of the CPI, while the core CPI, which excludes food and energy, comprises around 80%.
Lee further elaborates on the potential implications of significant drops in oil prices on the CPI. They suggest that a 20% decrease in oil prices could lead to a one-off reduction of approximately 0.3pp in U.S. headline CPI in the short term, with additional impacts of around 0.08pp through food CPI and 0.16pp through core CPI over the following two years.
A 33% fall in oil prices could mean a one-off 0.5pp reduction in headline CPI, with an additional 0.14pp through food and 0.27pp through core CPI over two years.
To achieve the Federal Reserve’s target inflation rate of 2%, Citi estimates that crude oil prices would need to fall to $53 per barrel, which would correspond to retail gasoline prices of approximately $2.60 per gallon, considering the slower pass-through via food and core CPI over two years.
Without accounting for second-round effects, a theoretical 50% drop in crude oil to $35 per barrel could single-handedly impact 0.8% of headline CPI.
The analysts also highlight that a decrease in oil prices could offer significant relief to U.S. consumers, with the potential to reduce household gasoline expenditure significantly over the next few years. However, they caution that inflationary pressures from U.S.-driven geopolitics and tariffs could offset any deflationary impact from lower energy costs.
The U.S. Economics team at Citi anticipates that 20% tariffs on China could increase core CPI by approximately 0.2pp from March to May 2025, with additional reciprocal tariffs adding around 0.3pp later in 2025.
Moreover, tariffs on Canada and Mexico, as well as steel tariffs, could result in higher U.S. crude and gasoline prices, while increased sanctions on Iran and Venezuela could support global oil prices.