US economic outlook July 2026

A resilient economy, renewed risks

• Moderate growth: As we enter the second half of the year, the US economy continues to advance at a moderate pace. Consumers continue to spend, even as some households have become more cautious and frugal amid an ongoing income squeeze. Many retailers are reporting increased price sensitivity while facing higher input costs stemming from renewed Middle East tensions and tariffs, creating pressure on margins. Business investment continues to expand, led by the ongoing AI investment surge, which is also contributing to higher prices for selected technology inputs, energy and software. Meanwhile, trade flows continue to swing widely, with businesses reporting a high degree of uncertainty surrounding the United States-Mexico-Canada Agreement and the potential impact of new Section 301 tariffs after the Section 122 tariffs expire at the end of July.
  
  
• Looking ahead, we continue to expect moderate consumer spending growth and AI-led investment to drive real GDP growth into 2027. The key downside risk to the outlook remains a renewed surge in energy prices that could lift inflation further and force the Federal Reserve to tighten monetary policy. Such an outcome could tighten financial conditions and weigh on one of the economy’s primary engines of growth — AI investment. Given the economy’s strong start to 2026, we have raised our real GDP growth forecast to 2.0% in 2026 and expect growth of 1.9% in 2027.
  
  
• Inflation cools, but risks remain: The June Consumer Price Index (CPI) report revealed a much less inflationary backdrop than feared. Headline CPI fell 0.4% month over month, driven lower by plunging energy prices, lowering inflation by 0.7 percentage points to 3.5% year over year (y/y). Core CPI edged down 0.02%, marking its weakest reading outside a recession since 2017 and pushing core inflation 0.3 percentage points lower to 2.6% y/y.
  
  
• Still, despite the encouraging report, three factors present upside risks to inflation in the coming months. Renewed tensions in the Middle East, including additional strikes and the US blockade, have pushed oil prices higher, raising the risk of renewed pressure on downstream commodity prices. While the pass-through from higher energy costs to core inflation has historically been limited — outside transportation-related categories such as airfare — a sustained increase in oil prices would pose a meaningful upside risk. Lingering tariff pressures also remain a concern, with a recent New York Fed study showing that roughly 45% of firms still plan to pass higher duties through to consumers. Finally, continued AI investment is likely to sustain pricing pressure in selected technology-related goods and software categories rather than broad consumer prices. Computer software prices, for example, are already up 17% y/y. Looking ahead, we expect headline inflation to move toward 3.4% y/y by December, while core CPI inflation eases toward 2.4%.
  
  
• Labor market stuck in second gear: The June employment report came as a surprise only to those expecting a labor market reacceleration. Payrolls increased a moderate 57,000, while sizeable downward revisions totaling 74,000 to April and May payrolls aligned with our expectation that the labor market would stabilize following the weakness observed in 2025. The three-month average pace of job growth slowed to a modest, albeit uneven, 111,000. 
  
  
• The simplest way to characterize today’s labor market is that it remains stuck in second gear. While conditions appear stable on the surface, there is little evidence of renewed momentum. The low unemployment rate should therefore be interpreted alongside subdued and concentrated job growth. Labor demand remains highly selective amid structural labor supply constraints stemming from demographics and lower net migration. Businesses continue to seek the right talent with the right skills at the right price, resulting in restrained hiring, selective layoffs and continued moderation in wage growth.
  
  
• Fed patience running thin: Recent Fed communication has increasingly converged around a simple message: After several months of upside surprises in core inflation, policymakers’ patience is running thin. The June CPI report was undoubtedly encouraging, but one favorable inflation print is unlikely to offset months of disappointing inflation data. If inflation does not begin moving lower “soon” (i.e., over the next one or two months), many Fed officials appear increasingly prepared to tighten policy further. While a July rate hike remains highly unlikely, the September Federal Open Market Committee meeting could become the first meaningful test of whether the recent improvement in inflation proves durable.
  
  
• Our base case remains that the Fed will stay on hold through the rest of the year, but it’s a 60–40 call. Indeed, the June median federal funds rate projections showed an even split, with nine Fed policymakers expecting at least one rate hike in 2026 and nine favoring no further tightening.

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.