Advanced economies facing the risk of stagflation

Advanced economies proved resilient in 2025 despite a tariff shock that disrupted global trade. By early 2026, they were on track for faster growth and lower inflation. A fresh shock linked to the war in the Middle East, however, is reigniting inflation while slowing growth. This mix primarily reflects the impact of a likely decline in purchasing power on consumer spending.

However, many of the factors that underpinned 2025 growth — AI development, higher defense spending (especially in Europe), and continued trade growth — are set to persist in 2026. They would be reinforced by an acceleration of electrification, against a backdrop of rising oil prices and an AI-driven rise in electricity demand.

These growth-supporting factors should limit the drag on growth to -0.4pp (on average), while the shock would add about 1.1pp to inflation.

Meanwhile, major advanced economies’ fiscal leeway has narrowed as public debts and interest rates have risen. Fiscal support for households would therefore be significantly less important than in 2022. At the same time, central banks will likely have to raise rates to prevent inflationary pressures from becoming entrenched. The ECB and the BoE are expected to follow suit. The BoJ is expected to continue the ongoing, very gradual monetary adjustment. The greatest uncertainty surrounds the Fed, but we still anticipate that it will remain on hold throughout the year.