Soaring diesel prices add new inflation pressure beyond oil shock, economists warn

Economists warn that soaring diesel prices are creating a distinct inflation pressure separate from the typical crude oil shock. A report from Scotiabank Economics notes diesel prices have climbed far beyond what a normal crude price move would imply. The increase is driven by shipping challenges in the Middle East and reduced refining capacity in Russia due to the Ukraine conflict. "These two events combined led to a crunch in the supply of diesel in the global market and sent prices higher," said Olivier Gervais, director of modelling and forecasting at Scotiabank Economics.

Scotiabank's analysis isolates diesel price movements not explained by crude oil. The economists calculate a temporary 15 per cent increase in the diesel spread would raise consumer price index inflation in Canada by 0.6 percentage points and by 0.8 points in the U.S. "We find clear evidence that the inflationary effects extend beyond energy in both Canada and the United States," said Gervais. This pass-through affects underlying inflation measures, not just headline figures. "When diesel prices rise independently of crude oil, the impact does not stop at the pump; it leads to broader price pressures later on," Gervais said.

The inflationary effect is gradual because diesel fuels trucking, agriculture, construction and manufacturing. Higher costs first push up transportation prices before spreading through production and distribution networks. Oxford Economics found U.S. trucking firms are already passing some of these higher fuel costs to customers. Price increases for food, shelter and other categories typically follow 12 to 18 months later as costs move through supply chains.

READ MORE: Rising diesel prices threaten to push food inflation higher after Thanksgiving

READ MORE: Bank of Canada governor warns high oil prices will push inflation forecast higher

Scotiabank warns a prolonged diesel shock could force a more aggressive monetary policy response. "Product-price shocks are usually short-lived, so that risk should not be overstated," said Gervais. "But the longer the shock endures, the greater the likelihood that firms pass on higher costs more forcefully, inflation expectations become more sensitive and monetary policy is forced to respond more aggressively." The Bank of Canada and the Federal Reserve might tolerate a temporary shock but would hike rates if broader inflation expectations rose. "With upside risks beginning to accumulate, this new shock adds fuel to the fire," Gervais said.

Even major oil producers like Canada and the U.S. are exposed to these global price increases for refined products. Oxford Economics noted that global markets set prices for both crude and diesel. "Even large producers such as the U.S. and Canada remain exposed to higher global crude and diesel prices despite having greater domestic supply security than major importers," the firm said. Historically, refined product prices move with crude but by a smaller margin. "This is no longer just an oil shock," Gervais concluded.

With files from Financial Post