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Section 2: The economy and markets
Key points to know
AI continues to drive global growth. The global economy enters the final stretch of 2026 on firmer footing than expected. Growth has proved resilient as AI-related capital spending, fiscal support and steady household demand offset the drag from higher borrowing and energy costs. The U.S. continues to stand out: We expect growth to remain above 2.0% this year and unemployment steadying near 4.1%. Europe has also held up better than anticipated despite the energy shock. We anticipate euro area growth at around 1.0%, while emerging markets growth remains comparatively firm.
The AI investment cycle is a key tailwind to U.S. activity and for economies embedded in the technology supply chain, such as Taiwan and Korea. Productivity gains should prove substantial but may lag, while the buildout’s energy and financing needs intensify competition for capital amid already elevated global yields.
Inflation remains the principal challenge. Elevated energy prices stemming from the ongoing Middle East conflict have interrupted disinflation. In the U.S., core PCE inflation should stay above 3.0% this year before easing to 2.5% in 2027. Our base case assumes energy prices moderate as geopolitical tensions ease, allowing disinflation to resume. A more persistent oil shock, however, would increase the risk of second-round effects and keep inflation above policymakers’ targets for longer.
The interest rate outlook remains uncertain, but points to still-high rates. Central bank policy paths hinge on how the energy shock evolves. We lean toward one further U.S. Federal Reserve hike by year-end, as near-term energy pressures risk feeding into underlying inflation. A meaningful drop in oil prices, however, could reduce that need. The European Central Bank faces similar upside risks, while the Bank of England confronts a difficult trade-off between sticky inflation and weak growth. The Bank of Japan looks set to keep removing accommodation gradually as wages and inflation anchor more firmly around its 2.0% target. Notably, all major global central banks have grown significantly more hawkish since midyear (Figure 1).
Geopolitics remain a wildcard. Energy price pressures are playing out unevenly across the globe, especially in emerging markets, where technology exporters and commodity producers are better placed than energy importers and highly indebted economies. Growth is holding up heading into 2027, even as renewed inflation pressures and tighter financial conditions leave policymakers less room for error. This volatility, combined with a cloudy outlook for the Middle East conflict and elections in the U.S. and elsewhere, could add further uncertainty in the months ahead.
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Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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