The big test for inflation is 12 months away

London(CNN Business) Annual consumer inflation in the United States has climbed to 7% as prices rise at the fastest clip in nearly four decades.

But the real test for prices is a year away.

What's happening: According to the most recent survey of consumer expectations by the Federal Reserve Bank of New York, which was published earlier this week, Americans expect inflation of 6% one year from now and 4% in three years' time.

That's much higher than forecasts from the Federal Reserve. The central bank projected at its December meeting that inflation would run at 2.6% in 2022.

Bond market investors, for their part, see inflation averaging 2.87% over the next five years.

Who's right? That will depend in large part on how effective the Fed is at tackling price increases through interest rate hikes. After pushing rates to near-zero at the beginning of the pandemic, the central bank is expected to hike borrowing costs soon in an attempt to cool off the economy.

Wall Street now sees a nearly 75% probability that the Fed will lift interest rates by 0.25% in March.

There are signs that consumers are increasingly confident that the Fed has matters under control. The New York Fed survey found that uncertainty about where inflation is headed decreased in December.

Fed Chair Jerome Powell also said Tuesday that he thinks a main contributor to inflation — pressure in global supply chains — will ease up this year, though some business leaders and industry analysts disagree. During his confirmation hearing before the Senate, he told lawmakers that his expectation is that supply chains "will loosen up."

But Powell conceded that if that doesn't happen, and inflation proves to be "even more persistent and higher," it would increase the risk of higher prices "becoming entrenched in the psychology" of businesses and households.

Why it matters: Inflation erodes consumers' spending power and forces them to make tough choices on what to buy, in turn hurting the economy. But a major concern now isn't whether serious inflation is going to hit — it has — but whether it's going to stick around, triggering a damaging feedback loop as businesses keep raising prices and workers demand higher wages to cover their costs. That's a much deeper problem.

Powell has said the Fed will respond more aggressively if that type of pattern emerges. Goldman Sachs now thinks the central bank will hike interest rates four times this year. JPMorgan Chase CEO Jamie Dimon said in an interview earlier this week that even that estimate may be conservative.

"It is possible inflation is worse than they think and they raise rates more than people think," Dimon told CNBC. "I'd personally be surprised if it is just four increases next year."

The takeaway: The December inflation data is an important snapshot in time. But lots of attention is now focused on what will happen once the Fed steps in more assertively in the coming months.

"The risk of a mistake goes up when you're rushing like this," economist Mohamed El-Erian told CNN Business.

Oil prices are back at two-month highs

US oil prices rose sharply on Tuesday, climbing above $81 a barrel for the first time in two months.

The latest: Crude closed at $81.22 a barrel, up nearly 4% on the day. It's the highest level for oil since Nov. 11, my CNN Business colleague Matt Egan reports. Prices are ticking up again on Wednesday.

The latest gains unwind a good chunk of the relief experienced in energy markets in recent weeks. Prices at the pump have also paused their recent retreat. The national average stands at $3.30 a gallon, up by a penny from a week ago, according to AAA.

Oil prices began tumbling in early November on rumors that the White House would intervene to cool off energy markets. President Joe Biden announced the largest-ever release of barrels from the Strategic Petroleum Reserve later that month.

Crude kept sliding on fears about the Omicron coronavirus variant, sinking to $65.75 a barrel by the start of December.

But oil closed on Tuesday about 24% above the recent lows.

Driving the gains: Investors are showing confidence that the effects of the Omicron variant on the global economy can be contained. That means robust demand for fuel is likely to continue. Supply may also be constrained as some members of the Organization of the Petroleum Exporting Countries (OPEC) and its allies struggle to hit increased production targets.

Prices are "buoyed by positive demand signals for 2022 and an expectation of global supply tightness," Louise Dickson, senior oil markets analyst at Rystad Energy, told clients Tuesday.

Watch this space: US government forecasters have revised up their gas price forecast.

The US Energy Information Administration now projects gasoline prices will average $3.06 a gallon in 2022. That's up from the EIA's early December forecast of $2.88 a gallon.

Inflation is high, but nowhere near its historical peak

Consumer prices in the United States may be rising at the fastest pace in 39 years, but there was a time when the situation was much worse.

Today's price increases are nowhere near as bad as they were in the 1970s and early 1980s, my CNN Business colleague Chris Isidore reports.

Inflation hit 12.2% in late 1974, soon after President Gerald Ford took office. That's nearly twice the 6.8% annual inflation America saw in November of last year.

The inflation rate hit a record high of 14.6% in March and April of 1980, contributing to President Jimmy Carter's defeat in that fall's election.

Economists say the United States isn't due for a repeat simply because many parts of the economy have changed significantly.

In the 1980s, a far greater portion of US workers were in unions and had contract provisions that automatically boosted wages as prices increased. As earnings rose, businesses kept hiking prices, feeding what was known as a "wage-price spiral."

Today, only about 12% of US workers are represented by unions, about half the rate of 1983.

Other factors: Competition from overseas imports also prevents companies from hiking prices as sharply. Plus, the US economy is less sensitive to the price of oil than it was a few decades ago.

"One of the most overlooked changes is the reduced energy intensity of the American economy," said Louis Johnston, economics professor at College of Saint Benedict in Minnesota.

Up next

KB Home (KBH) reports results after US markets close.

Also today: The latest data on US consumer inflation posts at 8:30 a.m. ET.

Coming tomorrow: Delta Air Lines (DAL) and TSMC earnings.