The Passthrough Problem

Brent moved from 61 to above 113 dollars inside a quarter. This report separates the realised physical shortfall from the priced risk premium, models the passthrough into headline and core inflation, and identifies the single assumption on which every current inflation forecast rests.

The shock in detail

Brent crude opened 2026 at 61 dollars a barrel. It stood at 71 on 27 February. Following military action in the Middle East beginning on 28 February and the consequent effective closure of the Strait of Hormuz to most shipping, it reached 94 by 9 March, crossed 100 within a fortnight, and traded above 113 on 23 March. Roughly a fifth of global oil flows transit that chokepoint.

As of 9 March, when the EIA finalised its March forecast, physical damage to oil infrastructure was limited but the strait was effectively closed. High uncertainty about the effect on supply has added a large risk premium as market participants weigh actual disruption against the possibility that it persists.

That distinction, between realised physical shortfall and priced risk premium, is the whole analytical problem. Risk premia unwind quickly when risk resolves. Physical shortfalls do not.

Three channels, three lags

An energy shock reaches consumer prices through channels operating on very different timescales. Conflating them produces bad forecasts, and most commentary conflates them.

Direct, within weeks

Motor fuel and household energy sit in the consumer price index and reprice almost immediately. Large, mechanical, and it reverses when the price does.

Indirect, two to four quarters

Transport and distribution costs, petrochemical feedstock, plastics, fertiliser. This is where a crude price becomes a food price and a goods price. Slower, smaller per unit, and much broader in coverage.

Second round, a year or more

Wage bargaining responds to realised inflation, which feeds back into prices. This is the only channel that converts a temporary shock into a persistent one, and it is behavioural rather than mechanical.

Everything that matters for monetary policy turns on whether the third channel opens. The first two are arithmetic.

Why the passthrough should be smaller than the analogy suggests

The comparison being drawn is to the 1970s, and one international agency has described the current crisis as resembling both of that decade's oil shocks occurring simultaneously. On the supply disruption that comparison has some force. On the inflation consequence we think it materially overstates.

Three structural differences argue for a smaller passthrough coefficient than historical episodes of comparable size. Energy intensity of output has fallen substantially across advanced economies, so a given percentage move in crude touches a smaller share of the cost base. The renewable share of generation has risen, partially decoupling electricity prices from oil. And inflation expectations start from a materially better anchored position than in 1973 or 1979, which is precisely the condition determining whether the second-round channel opens.

The supply response matters too. Inventory drawdowns, production outside the Gulf and demand-side policy all limit the physical shortfall relative to the price move. OPEC agreed on 1 March to begin increasing production in April by a total of 206,000 barrels a day in response to low inventories.

The critical assumption

The EIA expects near-term disruption and a persistent risk premium to keep Brent averaging 91 dollars in the second quarter, falling to an average of 70 in the fourth quarter and 64 across 2027. That path is not a forecast about geopolitics. It is a forecast about inventories: it assumes global oil production continues to outpace consumption once flows are reestablished, with stocks building by an average of 1.9 million barrels a day in 2026 and 3.0 million in 2027.

This is the single most load-bearing assumption in every inflation forecast currently being published, and it is not usually stated as such. If transit does not normalise, or if shut-in production returns more slowly than assumed, the whole disinflation path shifts out. We would treat any 2027 inflation projection as conditional on this and would ask to see it stress-tested before relying on it.

The monetary policy position

A supply shock raises prices and lowers output. There is no policy setting that improves both. Tightening addresses the inflation and worsens the growth; holding does the reverse. This is why supply shocks produce unusually visible disagreement inside monetary policy committees, and why the useful question is not what a central bank will do but what it is willing to tolerate.

Higher prices near these levels raise the risk of broader cost passthrough into transport, manufacturing and heating, which firms up headline inflation and complicates any path back to easing. The incidence across countries will be very uneven: energy exporters outside the conflict zone gain on terms of trade, energy importers with strong technology exports may find the two effects partly offset, and energy importers with an energy-intensive manufacturing base and no technology upside have nothing on the other side of the ledger.

Indicators to monitor

• Tanker transit volumes, not the price. Physical flow tells you whether the premium is justified. The price only tells you what the market currently fears.
• Core rather than headline forecasts. Headline rising with core stable is a shock passing through. Both rising together is propagation, and it changes the analysis completely.
• Wage settlements in indexed jurisdictions. This is where the second round would appear first if it appears at all.
• Inventory data. The whole 2027 path depends on it, so it is the series to check before accepting any of these numbers.

Our base case is that the mechanical passthrough completes without opening the second-round channel. The risk to that view is duration rather than magnitude: a shock of this size that persists for three quarters is a very different object from the same shock that resolves in one.

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