U.S. economy holds up as Iran conflict keeps inflation risk alive

American shoppers kept spending through the spring and early summer, even after the conflict with Iran disrupted a major oil-supply route and pushed inflation back into uncomfortable territory, according to MarketWatch.

The report said the economy’s two big engines, household spending and business investment, appear set to show solid growth for the second quarter. That has helped limit the damage from higher energy costs and supply headaches tied to the war.

The squeeze has still been real. MarketWatch reported that inflation climbed above 4% in May, its highest level in three years, and briefly moved faster than typical wage growth. That left consumers with less buying power.

Companies also had to look for new sources of important materials, including fertilizer, plastic and aluminum, the report said. Some businesses passed higher costs on to customers through price increases.

Consumers keep the cash registers ringing

Retail spending held up anyway, with car dealers and auto makers among the standouts, according to MarketWatch. Chris Low, chief economist at FHN Financial, told the outlet that strong vehicle sales are unusual when consumers are under pressure.

That spending matters because it can support corporate profits. MarketWatch reported that steady demand may help U.S. companies post strong second-quarter earnings, which in turn could support the stock market.

The report also linked resilient profits to the job market. Companies with healthy demand and profits have less reason to make broad job cuts, while low unemployment gives many households the confidence to keep spending.

Business investment is another prop under the economy. MarketWatch said companies are spending heavily on artificial intelligence, with some of that money going to overseas chip and memory suppliers and some circulating through the U.S. economy.

That investment has a downside. Demand for chips, memory and data-center materials is adding pressure to prices, according to the report.

GDP looks steady, but trade could muddy the picture

MarketWatch reported that second-quarter gross domestic product is expected to rise at a pace near the first quarter’s 2.1% growth rate. The report noted that GDP growth above 2% is generally viewed as better than average.

There is a catch: a larger U.S. trade deficit could weigh on the headline GDP figure. MarketWatch said a clearer read may come from looking at broader consumer spending and private-sector purchases of goods and services, where readings above 2% are considered healthy.

Bernard Yaros, lead U.S. economist at Oxford Economics, wrote that the U.S.-Israel war with Iran had thrown the economy a major curveball. Even so, Oxford Economics still expects growth above 2% this year, according to MarketWatch.

Oil, inflation and the Fed remain the danger points

The main risk now is another energy shock. MarketWatch reported that the U.S. is increasing attacks on Iran after peace talks failed, raising the possibility of another jump in gasoline prices.

Eugenio Aleman, chief economist at Raymond James, told MarketWatch that the outlook depends on what happens next in the conflict.

Oil prices have been around $80 a barrel recently, according to the report. Earlier in the spring, they rose as high as $115 after sitting near $65 before the conflict began.

MarketWatch also said the economy likely received temporary help from larger-than-usual tax refunds, while the World Cup probably gave activity a small lift, though the effect is difficult to measure in the data.

The Federal Reserve is the other wild card. The central bank could raise interest rates this year if inflation does not move quickly toward its 2% target, MarketWatch reported.

Recent drops in consumer and wholesale prices gave the Fed some relief, with consumer inflation falling for the first time in six years, according to the report. Those declines were largely tied to cheaper gasoline after the U.S. and Iran agreed to talks.

With fighting resumed, that progress could fade. MarketWatch cited a Wall Street tool showing only a 10% chance of a Fed rate increase at the July 28 meeting, while investors are more divided about September.

This story draws on original reporting from MarketWatch.