Rising tensions between the United States and Iran are creating additional challenges for the Federal Reserve as it tries to balance inflation control with maintaining a healthy labor market.

 Minneapolis Fed President Neel Kashkari offered insights Tuesday into the potential impact of the Iran war on the Fed’s decision-making.

Like many economists and policymakers, Fed officials are closely monitoring the evolving situation in the Middle East. The key questions remain how long the conflict will continue, whether it escalates further, and how much it will affect the global and U.S. economies.

One immediate impact has been the sharp rise in energy prices. Since the conflict began, West Texas Intermediate (WTI) crude oil has climbed roughly 8%, while the average price of regular gasoline in the U.S. has increased by about 10 cents to $3.11 per gallon, according to data from AAA.

Higher energy prices could complicate the Fed’s efforts to bring inflation back to its 2% target. If the conflict continues or expands, disruptions to Middle Eastern oil exports may put additional upward pressure on fuel costs and broader consumer prices.

Federal Reserve officials have acknowledged the uncertainty surrounding the situation. Minneapolis Fed President Neel Kashkari noted that the conflict could either have a limited impact on inflation, similar to the Israel-Hamas war in 2023, or lead to a larger shock similar to the inflation surge following Russia’s invasion of Ukraine in 2022.

Speaking at a Bloomberg event, Kashkari emphasized that geopolitical events affecting inflation cannot simply be ignored when setting monetary policy, although it remains too early to determine the long-term consequences of the current conflict.

New York Fed President John Williams also commented on the situation, saying financial market reactions so far appear relatively contained. However, he stressed that policymakers will need to monitor whether the effects on inflation and economic activity prove temporary or persistent.

The added geopolitical uncertainty comes at a time when the Fed is already debating its next policy move. Some officials remain concerned that inflation, which recently rose around 3% year-over-year according to the Fed’s preferred measure, continues to stay above the central bank’s target. Others are increasingly focused on signs of slower job growth, even though the labor market has largely avoided major layoffs.

Kansas City Fed President Jeffrey Schmid recently warned that inflation has remained above the Fed’s goal for several years and that policymakers cannot afford to relax their vigilance too soon.

Despite these concerns, some officials remain optimistic that inflation pressures may ease later this year. Williams suggested that the impact of tariffs on consumer prices could begin to fade over time, potentially allowing inflation to move closer to the Fed’s target.

Before the outbreak of the conflict, many investors expected the Federal Reserve to begin cutting interest rates later this year as inflation gradually cooled. However, rising energy costs and geopolitical risks could delay that timeline.

Market expectations have already started to shift. According to CME Group’s FedWatch tool, traders now see a 56% probability that the Fed will keep interest rates unchanged through June, up from about 50% just a week earlier.

As the situation in the Middle East continues to unfold, the path of U.S. monetary policy may become even more uncertain, with energy prices and geopolitical risks playing a key role in shaping the Fed’s next decisions.

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