Global Economic Outlook: risk and opportunity in a supply shock world

Midyear outlook: Trade tensions, energy shocks and fragmentation are slowing growth, while AI and strategic adaptation create opportunity.

In brief

• Global growth is slowing as geopolitical tensions, tariffs and supply-side disruptions raise costs and increase economic fragmentation.
• Higher energy prices, persistent inflation pressures and elevated uncertainty are creating a more challenging environment for businesses and policymakers.
• AI adoption, productivity gains and strategic resilience offer opportunities for organizations prepared to adapt to a changing economic landscape.

To jump to a specific section, click one of the links below:

• Risk and opportunity in a supply shock world
• Regional bifurcation
• Rising inflation and fragmented monetary policy
• Five themes: navigating a world of supply shocks and strategic realignment
• Economic outlook for major economies
• Strategies to thrive in a new economic paradigm

Risk and opportunity in a supply shock world

The global economy has demonstrated resilience through successive shocks, but that resilience is increasingly under strain. The risk of drifting toward a more fragmented and structurally weaker trajectory is rising, even as technological innovation continues to offer the potential for stronger productivity and a more durable expansion.

Our EY-Parthenon outlook points to a meaningful but not recessionary global slowdown, with growth easing from 3.4% in 2025 to 2.9% in 2026 — down from our December 2025 forecast of 3.1% — before firming to 3.2% in 2027.

The more important story is not the size of the downgrade but the changing nature of the global economy. Before the Middle East conflict, the drag from tariffs, trade fragmentation and elevated policy uncertainty was partly offset by robust AI-related investment, supportive financial conditions and policy easing across several major economies. The conflict has introduced another supply-side shock through energy, commodities, shipping routes and financial conditions, adding pressure to an already complex operating environment. While a US-Iran peace deal could lead to lower inflation and stronger growth, uncertainty remains elevated.

More broadly, the global economy is entering a new paradigm shaped by layered supply shocks — geopolitical conflict, tariffs, industrial policy, energy-security concerns, demographic constraints and uneven technology diffusion. These forces are raising the cost of growth, reducing efficiency and gradually weighing on medium-term potential, even as headline activity remains resilient. AI-related investment provides an important offset, but it is also creating bottlenecks and price pressures in energy, semiconductors, data centers and other AI-linked inputs.

The recent wave of tariffs has not triggered a collapse in global trade, supported by carve-outs, partial tariff rollbacks, corporate hedging strategies and supply-chain reconfigurations. Even so, trade restrictions, export controls and industrial policy are reshaping investment flows, raising operating costs and accelerating supply-chain regionalization, particularly in sectors tied to semiconductors, energy and critical minerals. A broader escalation in geopolitical tensions remains a key downside risk to the outlook, while stronger productivity gains from AI represent a notable upside risk.

Emerging markets continue to show uneven resilience. China continues to face intensifying structural headwinds, including a prolonged property-sector downturn, demographic aging, weak consumer demand, excess industrial capacity and slowing productivity growth. Despite ongoing policy support, these pressures, together with the energy shock from the Middle East conflict, are expected to weigh increasingly on growth prospects in the short and medium term.

India remains the fastest-growing major economy, supported by strong domestic demand, infrastructure investment and continued services-sector momentum. The easing in additional US tariffs on Indian exports should provide some support to activity, helping offset part of the drag from weaker global demand and heightened energy prices.

Across Latin America, growth is expected to remain relatively resilient as several economies benefit from higher commodity prices. However, US tariffs and trade policy uncertainty will continue to weigh on activity, alongside tight financial conditions, localized food supply shocks and political uncertainty in some jurisdictions. While growth in Brazil has moderated, it should remain relatively resilient, supported by expansionary fiscal policy, gradual monetary easing and the country's position as a net commodity exporter, despite softer global demand and higher input costs. Mexico is expected to recover gradually following a weak 2025, but fiscal consolidation, renewed inflationary pressures and ongoing trade uncertainty are likely to restrain the pace of expansion.

For economies in the Middle East, the economic impact of the conflict is likely to be far more severe. Disruptions to energy production, transportation infrastructure and trade routes are materially weakening activity across parts of the region, particularly where export flows remain heavily dependent on maritime transit through the Strait of Hormuz.

Rising inflation and fragmented monetary policy

Global inflation is expected to move higher in 2026 before easing gradually in 2027, highlighting the increasingly supply-driven nature of the current inflation cycle. The inflationary shock from the Middle East conflict, via higher energy, commodities and food prices, and tariff pass-through are contributing to renewed regional price pressures even as global demand softens. Inflation dynamics are also becoming more uneven across economies, reflecting differences in energy exposure, underlying demand strength and labor market conditions as well as domestic policy settings.

Monetary policy remains cautious and increasingly fragmented as central banks balance slowing growth against renewed inflation pressures, financial stability risks and heightened sensitivity around policy credibility. The Federal Reserve (Fed) is expected to remain on hold into 2027, while adopting a more explicitly two-sided reaction function that leaves the possibility of rate hikes should inflation prove more persistent or inflation expectations become unanchored. The European Central Bank (ECB) is expected to tighten policy from its broadly neutral stance, while the Bank of England (BoE) is expected to maintain its restrictive monetary plan but could eventually be compelled to tighten policy further. In Japan, policy normalization is expected to continue gradually amid firmer inflation and heightened market volatility.

Across emerging markets, monetary policy paths are diverging more visibly as growth slows and inflation pressures evolve unevenly across regions. Some central banks, including those in Brazil and Turkey, retain scope to provide modest support to activity as growth weakens and inflation gradually moderates. Others, including India and Indonesia, are likely to tighten policy cautiously in response to higher energy prices, currency pressures and the risk of second-round inflation effects from the Middle East conflict.

Overall, the global outlook remains fragile, with risks tilted to the downside. A broader Middle East conflict or a sustained rise in energy prices could tighten financial conditions further, amplify inflation pressures and weaken global demand. At the same time, elevated asset valuations, rising sovereign borrowing needs and persistent trade tensions leave the global economy more exposed to market volatility and policy missteps. Faster-than-expected AI adoption remains the main upside risk, particularly if productivity gains broaden beyond a narrow set of firms and sectors.

Five themes: navigating a world of supply shocks and strategic realignment

Businesses entered 2026 facing a more complex operating environment. Supply-side disruptions are no longer isolated shocks. They are becoming more persistent, interconnected and strategic, shaping cost structures, investment decisions and competitive dynamics across sectors. The recent escalation in Middle East tensions reinforces this shift, increasing risks around energy markets, transportation corridors, supply chains and inflation expectations at a time when the global economy is already adjusting to higher tariffs, industrial policy shifts and tighter geopolitical alignment.

For business leaders, the challenge is no longer simply navigating cyclical swings in demand. It is operating in a world where labor availability, financing costs, energy security, supply-chain resilience and access to strategic technologies increasingly determine growth and profitability. Resilience and flexibility are becoming essential, but they also carry costs. Redundancy, regionalization and strategic stockpiling can reduce exposure to disruption, but they also weigh on efficiency, margins and capital intensity.

1. Geo-economic fragmentation

Geopolitical and trade tensions remain major sources of supply-side volatility. The Middle East conflict has added another layer of pressure through higher energy and commodity prices, transportation disruptions and renewed uncertainty around critical trade routes. Under our baseline scenario, the conflict is expected to reduce global growth by around 0.6 percentage points (ppt) to 2.9% y/y in Q4 2026 while lifting global inflation by around 1.7ppt to 4.7% y/y in Q4 2026. The impact is likely to be highly uneven. Commodity-importing, fossil-fuel-dependent and lower-income economies face a sharper squeeze from higher input costs, weaker real incomes and tighter financial conditions, while energy exporters outside the region may see some near-term support from higher prices that could eventually be offset by softer global demand. Economies directly affected by the conflict are expected to experience a sharp contraction in activity as energy production, refining and liquefaction capacity as well as trade routes are disrupted.

Our geoeconomic scenarios suggest stagflationary risks will become materially larger if the conflict broadens or persists for longer.

• Adverse scenario: Under an adverse scenario, disruptions to energy exports and regional shipping routes persist through 2026, keeping commodity and transportation costs elevated for longer. Brent crude oil prices would end the year around $100 per barrel relative to $88 in our baseline while global growth would be reduced by around 0.3ppt to 2.3% y/y in Q4 2026 and global inflation would be 0.7ppt higher at 5.4% in Q4 2026.
  
  
• Severe scenario: Under a more severe scenario involving broader damage to regional energy infrastructure and sustained disruption through the Strait of Hormuz, the drag on activity would become substantially larger with recessions across major economies. Brent crude oil prices would end the year around $150 per barrel relative to $88 in our baseline while global growth would be reduced by around 1ppt to 1.6% y/y in Q4 2026 and global inflation would be 2.2ppt higher at 6.9% in Q4 2026.
  
  
• Optimistic scenario: By contrast, an optimistic scenario centered on a faster de-escalation, stabilization in energy markets and normalization in shipping flows would reduce inflation pressures and support a modest rebound in global growth relative to our baseline forecast. Brent crude oil prices would end the year around $74 per barrel relative to $88 in our baseline while global growth would be increased by 0.3ppt to 2.9% y/y in Q4 2026 and global inflation would be 0.6ppt lower at 4.1% in Q4 2026.

Trade policy remains another major source of structural disruption. The average US tariff rate has risen sharply since 2024, from roughly 2.4% at the end of 2024 to over 10% in mid-2026, marking a significant realignment of global cost structures. Looking ahead, current assumptions incorporate the extension of Section 122 tariffs under alternative statutory frameworks. The effects are already visible in trade patterns. US-China trade volumes have fallen more than 35% from a year ago, even as US trade with the rest of the world has continued to rise modestly.

Policy uncertainty is also likely to remain elevated beyond 2026. Several recently negotiated trade arrangements provide only temporary relief, while the mandatory review of the United States-Mexico-Canada Agreement (USMCA) scheduled for mid-2026 could reopen broader questions around North American trade integration, investment rules and regional supply-chain strategy.

In general, businesses are responding by diversifying suppliers, rerouting production and embedding tariff exposure directly into sourcing, pricing and capital-allocation decisions. Inflationary effects are also becoming increasingly visible, with tariff pass-through having added roughly 0.8 ppt to consumer price inflation in the US.

2. Markets in flux

Financial markets remain unsettled as supply shocks, fiscal pressures and uneven policy paths reshape expectations around inflation, interest rates and capital flows.

In the wake of the Middle East conflict, long-term yields have reached multi-year highs across major economies. In the US, the 30-year Treasury yield has moved above 5%, its highest level since 2007, while Japan’s 30-year yield has risen to levels not seen since the late 1990s. UK gilt yields have seen the strongest increase among advanced economy peers as borrowing needs, inflation-linked government spending and political uncertainty keep pressure on public finances, while euro area yields have also moved higher in response to the inflation shock, public measures to buffer price pressures and fiscal trajectories. The common thread is a repricing of term premia driven by inflation uncertainty, rising sovereign issuance, fiscal concerns and growing sensitivity around central bank credibility.

At the same time, markets are increasingly pricing in the possibility that central bank policy rates may need to remain restrictive for longer and, in many economies, move higher again if inflation and inflation expectations rise persistently. This shift matters for businesses because the cost of funding is rising across both the public and private sectors. Higher discount rates can crowd out private investment, weigh on valuations and gradually erode economic momentum, particularly outside the narrow set of AI-related sectors that have, so far, remained relatively insensitive to rates.

Meanwhile, equity markets have continued to rise, supported by strong earnings expectations and elevated valuations, especially in AI-linked sectors, but they are not immune to correction. A reassessment of AI profitability, slower-than-expected monetization or persistently higher discount rates could place significant pressure on valuations and tighten financial conditions. The risk is not that all investment stops, but that capital becomes increasingly concentrated in a few high-conviction themes while broader investment flat-lines.

Commodity markets are reinforcing these pressures. Oil, industrial metals, rare earths and gold have become more sensitive to geopolitical tensions, supply constraints and strategic competition, contributing to greater price volatility and a more uncertain cost environment for businesses.

For businesses, this points to a financial environment that is likely to remain volatile and more restrictive than headline growth alone would suggest. Higher long-term interest rates, elevated funding costs, shifting commodity prices and currency volatility reinforce the need for disciplined balance-sheet management, adaptive hedging strategies and flexible capital planning.

3. Debt, deficits and policy credibility

Fiscal policy is entering a more constrained phase as structural and cyclical pressures converge. Structurally, higher public debt levels and elevated interest rates are pushing government debt-servicing costs materially higher, absorbing a growing share of public revenues and narrowing the space for growth-enhancing investment. Governments are simultaneously facing rising spending demands tied to defense, industrial policy, energy security and aging populations. At the same time, many are deploying fiscal measures to mitigate the impact of higher energy prices and protect household purchasing power. Importantly, several major economies continue to run sizable fiscal deficits despite resilient labor markets and the absence of deep recession conditions, highlighting the increasingly structural nature of fiscal deterioration and the narrowing scope for future countercyclical support.

Budget deficits are widening again across several major economies. In the US, fiscal deterioration is being driven by a combination of higher structural spending commitments, rising interest costs and only partial offset from tariff revenues, with public debt continuing to climb from already elevated levels. In Europe, defense and infrastructure spending are becoming increasingly important fiscal drivers, particularly in Germany, while Japan’s fiscal stance is expected to remain expansionary as policymakers continue to support domestic demand and cushion the effects of higher energy costs. Across emerging markets, fiscal trajectories are becoming more differentiated, though higher borrowing costs and rising debt burdens continue to constrain policy flexibility.

The broader implication is that long-term borrowing costs may remain structurally elevated even as some central banks eventually ease policy. Investors are increasingly focused not only on inflation dynamics, but also on fiscal sustainability, sovereign financing needs and institutional credibility.

For businesses, this points to a world in which fiscal policy is less able to absorb shocks and where government support becomes more selective and strategic. Higher structural borrowing costs, greater competition for capital and more targeted industrial-policy incentives are likely to become increasingly important features of the operating environment.

4. AI promises and misunderstandings

AI remains one of the few supply forces with the potential to offset slower labor-force growth and geoeconomic headwinds. But as with earlier technological revolutions, the first phase is largely about building the foundation. This includes heavy investment in data centers, semiconductors, cloud capacity and energy infrastructure, alongside rising corporate spending on AI integration.

That foundation is already supporting growth. AI-related activity, including infrastructure buildout, semiconductor production, model training, software deployment and cloud expansion, accounted for a significant share of US private-sector growth in 2025. Outside the US, the economic impact remains considerably more limited, reflecting lower levels of investment and a slower pace of commercialization.

Nevertheless, our research suggests that broader AI diffusion could generate the equivalent of one to two additional years of global growth over the coming decade, with the largest gains stemming from stronger productivity growth. Faster-than-expected adoption across firms and sectors could amplify those gains further, particularly if AI enhances operational efficiency, accelerates business formation and improves knowledge-worker productivity.

The benefits are unlikely to be distributed evenly, however. Differences in investment, digital infrastructure, workforce skills and regulatory frameworks are already creating significant disparities in adoption rates across countries and regions. As a result, AI has the potential not only to lift global productivity, but also to widen existing gaps in economic performance and competitiveness.

The challenge is that this first phase is also highly capital-intensive and potentially inflationary. Data centers require large upfront investment, electricity demand is rising rapidly and many firms are still absorbing the implementation costs associated with AI integration. Due to significantly higher investment demand, that price impact is so far concentrated primarily in the US, though it is likely to spread across the globe. At the same time, financial-market enthusiasm around AI has accelerated quickly, raising the risk that market expectations move ahead of realized productivity gains. A slower monetization cycle, disappointing productivity outcomes or overinvestment in AI infrastructure could trigger a broader reassessment in equity valuations and capital spending plans.

Adoption patterns also remain uneven. Consumer adoption has accelerated rapidly across households, particularly through AI-enabled search, digital assistants and productivity applications, while business adoption has progressed more gradually as firms work through integration costs, governance frameworks, cybersecurity concerns and workforce implications. The EY-Parthenon Growth Survey shows that 78% of business leaders see strong growth potential from AI, yet two-thirds remain in the early stages of adoption and 34% don’t yet trust AI for high-stakes opportunities. The next phase will require moving beyond experimentation toward broader deployment, workforce adaptation and a more deliberate integration of technology and human capital.

The labor-market transition is also likely to become more complex as businesses balance automation needs against workforce adaptation. AI is already improving productivity across information services, finance and professional sectors, but it is also beginning to reduce demand for some routine cognitive tasks. Firms that invest early in skills development, workforce adaptation and organizational redesign will be better positioned to capture productivity gains while limiting operational disruption.

For business leaders, the priority is not simply adopting AI. It is identifying the right combination of talent, technology and operating-model redesign that can improve productivity while managing rising infrastructure costs, workforce transition and capital-allocation risk.

5. Demographics and labor supply

Demographic change is becoming a direct constraint on growth. The global population aged 65 and older is expected to rise from roughly 10% today to nearly 20%, or about 1.6 billion people, by the middle of the century. At the same time, more than two-thirds of the global population now lives in countries with fertility rates below the 2.1 replacement rate, pointing to slower labor-force growth across much of the global economy.

The macroeconomic implications are significant. Slower labor-force growth is reducing potential output growth and increasing reliance on productivity gains to sustain the pace of expansion. Aging populations are also placing additional strain on public finances through rising pension, health care and social spending obligations, while contributing to more persistent labor shortages in service sectors where automation is more difficult and wage pressures tend to be stickier.

Immigration, once a reliable offset to population aging in many advanced economies, is becoming less effective as policies tighten and migration flows slow. This is increasing the risk of persistent labor shortages, particularly in sectors already facing elevated turnover rates and skills mismatches. At the same time, demographic divergence is becoming a more important driver of global competitiveness, with countries able to attract, retain and upskill workers likely to capture a larger share of global investment, manufacturing capacity and supply-chain activity.

Demographic trajectories are diverging markedly across regions. Japan is facing some of the most acute near-term declines in labor supply, while workforce growth in the US, Europe and China is broadly stagnant. By contrast, countries benefiting from stronger population growth or sustained immigration—including Australia, Canada and India, as well as many economies across Latin America and Africa—are likely to enjoy a more favorable labor-supply outlook.

It is critical for businesses to embed demographic trends directly into long-term planning. Tighter labor supply reinforces the need for automation, reskilling, retention and workforce redesign. Demographic transitions will also reshape demand across health care, housing, financial services, consumer markets and mobility. Firms that adapt early to these structural shifts through automation, workforce redesign and productivity-enhancing investment will likely be better positioned to manage labor-cost pressures, secure talent and capture new sources of demand and growth.