By Brian Coulton, Chief Economist, Sovereign and Supranational Group, Fitch Ratings
The jump in oil prices after the outbreak of the Iran-US-Israel war in February and the surge in US and global spending on AI-related investment capex (capital expenditure) have rekindled financial markets’ fears about inflation. This was initially expected to be the year when the US Federal Reserve (the Fed) would finally feel comfortable lowering rates back to neutral levels, as the tariff shock faded and inflation started to converge towards the 2-percent target. In the event US inflation rose back above 4 percent in May, US Treasury 10-year bond yields have climbed by 40 basis points (bps) since the start of the year, and swap markets are now pricing in a Fed hike by the end of 2026.
The sharp rise in oil prices in March—up to US$100 per barrel (Brent) from US$62 at the turn of the year—once again demonstrated the capacity for geopolitical developments to upend economic forecasts and deliver shocks to the world economy that policymakers cannot ignore. Fitch has raised its forecast for the 2026 annual average oil price to US$87 per barrel, a 27-percent increase on last year’s average.
Oil markets were oversupplied heading into the conflict, and inventory drawdowns and rising production outside the Gulf have helped cushion the impacts of the disruption to OPEC’s (Organization of the Petroleum Exporting Countries) oil exports caused by the prolonged closure of the Strait of Hormuz shipping route. And the shock has been far less severe than that seen in 1979, when the oil price reached US$170 in today’s money and when the oil intensity of gross domestic product (GDP) was much higher. Nevertheless, the higher oil price was the key driver of sizeable, widespread cuts to Fitch Ratings’ GDP forecasts in its latest Global Economic Outlook—June 2026.
Forecast downgrades would have been larger were it not for stronger-than-expected AI-related investment growth in the United States.
Forecast downgrades would have been larger were it not for stronger-than-expected AI-related investment growth in the United States. Private-sector investment in IT (information technology) equipment and software rose by 15.5 percent in real terms in 2025 and by 18.1 percent in the year to the first quarter of 2026 (2026Q1). IT investment reached US$1.6 trillion (annualised) in 2026Q1, up from US$1 trillion in 2021. This was equivalent to 4.9 percent of GDP, surpassing the previous peak of 4.5 percent in late 2000 at the height of the internet revolution. IT investment directly contributed 0.6 percentage points to US real-GDP growth in 2025, nearly a third of the overall real-GDP growth of 2.1 percent. However, IT capex is highly import-intensive, and a surge in capital-goods imports saw a large drag on growth from net trade in 2026Q1.
The IT-capex boom has been accompanied by a surge in global trade in semiconductors and electronics. Global semiconductor sales rose by 104 percent in the year to May 2026, far exceeding previous growth peaks. This has helped semiconductor producers in Asia, including Taiwan, Korea and China, where recent export performances have been extremely strong. The heavy geographical concentration of global IT-hardware production meant that the overall world trade-volume growth picked up sharply to 4.2 percent in 2025, outstripping world GDP growth. The sharp rise in the ratio of world trade to GDP was quite striking in a year when the world’s largest importer implemented the largest tariff hikes since the 1940s.
The AI boom has also supported growth through its impact on equity markets and the corresponding wealth gains for US households. Fitch’s estimates suggest that the wealth effect may have boosted US consumption by 0.4 percentage points in 2025. This has been a key source of support for US consumer spending over the last couple of years in the face of a clear slowdown in household-sector real income growth. The corollary of this has been a sharp fall in the household savings ratio from 6 percent at the start of 2024 to just 3 percent in May.
Nevertheless, the rise in headline inflation will take a toll on US consumers over the next six months. Real wages are no longer growing year-on-year, and employment growth is still relatively weak at 0.3 percent year-on-year. We expect US consumer-spending growth to slow from 2.6 percent in 2025 to 1.7 percent this year. This is the main reason we expect US GDP growth to moderate to 1.9 percent this year from 2.1 percent in 2025, even as private-sector investment growth picks up to nearly 4 percent.
The oil-price shock has also dampened prospects for a recovery in the eurozone.
The oil-price shock has also dampened prospects for a recovery in the eurozone. While the energy shock is far less severe than the one Europe faced in 2022 when Russia restricted pipeline supplies of natural gas, higher inflation will weigh on consumer spending and investment. Business and household confidence were hit hard by the oil crisis, and with nominal wage growth running at around 2 percent, the recent rise in headline inflation implies a fall in real wages. Credit conditions have also tightened in the eurozone, with German bond yields increasing, interest rates on household and corporate debt rising, and banks tightening lending standards on consumer credit and loans to firms. Credit growth has recovered nicely in response to the European Central Bank’s (ECB’s) earlier interest-rate cuts, but higher market and ECB policy interest rates could weaken this dynamic.
Volatility in Irish GDP has made headline eurozone growth numbers hard to interpret in recent years, but for the four largest eurozone economies (Germany, France, Italy and Spain) in aggregate, growth is forecast to be 0.9 percent this year. This forecast is no better than the 2025 outturn and has been revised down by 0.4 percentage points because of the oil shock. The step-up in European defence spending is providing some support to demand—we estimate it will boost GDP in Germany by 0.8 percent over the next three years—but the impact on overall eurozone growth will be marginal.
China’s increasing reliance on exports to drive GDP growth also poses a potential challenge to the eurozone’s growth and competitiveness. Consumer spending has languished in China since the pandemic, and fixed-asset investment has fallen over the past nine months or so. Overall GDP growth remained solid at 5 percent in 2025, but it was held up only by a large fiscal deficit and very robust exports. Export volumes rose nearly 9 percent in 2025—implying major gains in China’s share of global export markets—and the balance of trade in goods and services increased to 4.2 percent of GDP, the largest surplus since 2009. With China’s exports to the US now heavily constrained by high tariffs, they have increasingly been directed elsewhere, including to Europe, where the bilateral trade deficit with China has widened. While we expect China’s GDP growth to moderate to 4.6 percent this year, rebalancing looks unlikely any time soon.
Kevin Warsh has taken over as Fed chair with both a strong personal agenda for change at the institution and a challenging set of macroeconomic circumstances. Adverse supply shocks are always difficult for inflation-targeting central banks to respond to, as they raise prices while simultaneously reducing output. In the Fed’s case, they have potentially put its dual objectives of maximum employment and price stability into conflict. But Warsh has wasted no time in laying out that his priority is price stability, and he has been overtly critical of the Fed’s recent track record, with inflation above the 2-percent target for five consecutive years. And while he sounds bullish on AI’s potential to boost productivity in the medium term, his recent commentary has focussed more on the potential near-term inflationary impacts from the surge in IT investment.
This hawkish tone, along with the jump in headline inflation and the slight firming of monthly payroll gains, has led market expectations to shift firmly in favour of a rate hike later this year. This is still far from certain, though, given the slowdown in wage growth and the fallback in core CPI (Consumer Price Index) inflation to 2.6 percent in June. But one factor the Fed is likely to watch closely is corporate pricing power. The ability of US firms to protect and even increase profit margins in the aftermath of the 2021 shock to imported input prices was a major factor behind US inflation proving much more persistent than initially expected after the pandemic. Margins and growth in unit profits have been rising again in the US of late, which could amplify and prolong the impact of the oil-price shock on inflation.
The bond market has reacted to the shifting inflation and policy-rate outlook, with the yield on the 10-year United States Treasury (UST) rising to 4.6 percent from 4.2 percent at the start of the year. Warsh’s plan to assign a task force to review options for shrinking the Fed’s balance sheet may also have weighed on bond prices as markets digest the possibility of a significant fall in the Fed’s UST holdings in the medium term. Meanwhile, nervousness about elevated equity-market valuations remains palpable, as markets digest the increased risk of further tightening in global financial conditions.
Brian Coulton is the Managing Director and Chief Economist at Fitch Ratings. Before assuming his current role, he served as an Emerging Market Strategist at Legal & General Investment Management (LGIM) and held several senior leadership positions at Fitch, including Head of Asia-Pacific Sovereigns and Head of EMEA Sovereigns and Global Economics. Earlier, he was an Economic Adviser at HM Treasury.