David Rees, Head of Global Economics at Schroders, George Brown, Senior Economist at Schroders, Irene Lauro, Senior Economist - Europe and Climate at Schroders, Tina Fong, Strategist at Schroders, Sophieya Thirugnanasampanthan, Economics Intern at Schroders

Whatever the longer-term outcome in the Middle East, inflation is set to rise around the world. But interest rates are unlikely to follow.

What a time to be an economist. We entered the year expecting growth to beat expectations, but the immediate inflation shock due to events in the Middle East means we have trimmed our growth forecasts. Energy prices dominate the newsflow and we assume they will remain elevated until Q3. However, broad price pressures, coming through food and manufactured goods, are also likely to squeeze real incomes and weigh on growth. As a result, we now expect global GDP growth of 2.5% this year and 2.6% in 2027, down from 2.9% and 2.7% respectively.

In contrast to the previous commodity price shock in 2022 following the Russian invasion of Ukraine, the global economy has less momentum, policy is far less stimulatory and households do not generally have large savings to weather price rises. We expect major economies to skirt recession, but while it is a close call we believe weaker growth should prevent the risk of significant second round inflation and negate the need for interest rate hikes.

However, the supply shock will impact economies in different ways. The US is relatively insulated, whereas the Eurozone and UK are highly vulnerable, while it feels like a coin toss when considering the chances of re-escalation or resolution of tensions in the Middle East. We discuss this broad range of outcomes in our Global section.

In the US, the Iran conflict has meaningfully altered the near‑term policy calculus for the Fed. Rate cuts this year were never justified by fundamentals in our view and they now look less likely. The more pressing question is whether policy simply stays on hold in 2026 or whether persistent inflation forces the Fed into tightening. Our base case is that they will refrain from hikes before returning to easing policy in 2027, but it’s a close call.

Growth momentum in the Eurozone is fading after the energy shock, with PMIs signalling contraction and services losing resilience. This backdrop reduces the risk of second‑round inflation effects, making market pricing of two ECB rate hikes this year look too aggressive in our view.

Similarly in the UK, the MPC faces an uncomfortable trade‑off as another energy shock coincides with an already fragile domestic backdrop. Markets priced in as many as four hikes at one point, but we suspect the Bank will instead talk tough and stop short of tightening policy.

Japan’s economy should be bolstered by fiscal stimulus and firm wage growth. This, along with higher energy costs and a weaker currency are set to keep inflation above target. As a result, the Bank of Japan is likely to press on with gradual policy normalisation.

Upbeat growth and emerging price pressures have raised hopes that China’s economy will finally snap out of three years of deflation. China may be able to export supply-side price pressures to add upside to global goods inflation, but the continued housing bust means that hopes for sustained domestic reflation are ultimately likely to be dashed. The macro backdrop has already begun to weigh on equities again and may eventually curb renminbi appreciation.