Macro Views: Resilient regions, rising risks—2026 economic outlook

• Despite US President Trump’s tariff shock earlier this year, which briefly fueled fears of an impending recession, economic growth has thus far remained resilient. This strength largely reflects the easing of financial conditions driven by market optimism around AI and the sharp rise in AI-related capital spending, which has helped offset some of the drag from other sources of growth. However, this AI-driven boost has not prevented the ongoing multi-year cooling in the labor market, enabling the Fed to resume rate cuts, including an additional 50 basis points (bps) of easing since September.

• Consumer spending has held steady. High‑frequency sources show consumer spending holding its 18‑month trend. Before the US government shutdown, August personal income data showed real spending had begun to outpace disposable income and real wage growth, driven by stronger services spending after annual revisions. This resilience likely reflects the wealth effect among affluent households which have benefited from equity market gains tied to the AI boom, offsetting tariff-related pressures on lower-income groups. Aggregate weekly payrolls for non-managerial workers continue to grow faster than consumer prices, and household balance sheets remain healthy, with rising real net worth across income groups.

• We expect eurozone to see a sequential growth pick up in 2026, driven by several internal factors. Domestic demand should gain momentum from the fourth quarter of 2025 onward, supported by healthy real disposable income growth and continued investment. Fiscal policies vary across countries but generally lean slightly expansionary, with Germany providing a particularly strong, though sometimes underrated, fiscal impulse. Export growth will likely continue to face stiff competition from China, but global exports have held up well so far. Disinflation is likely to persist, with headline inflation likely averaging below target due to lower energy prices and a previously stronger euro. Markets anticipate the ECB will keep interest rates unchanged for an extended period, as both rate cuts and hikes seem unlikely unless there are significant changes in inflation or growth.

• Private consumption in the euro area is strengthening, running at 1.3% year-over-year in the third quarter, despite high uncertainty and low consumer confidence. This resilience is largely due to a robust labor market, which has been a key pillar of the region’s economic stability. Employment growth is cooling, given years of labor hoarding, but remains positive, which should also support a cyclical uptick in productivity. Weakness in Germany’s labor market is mainly in the industrial sector, which is expected to benefit from increased defense spending. Moreover, participation rates are at historical highs while unemployment is close to its lowest levels, at 6.4%, with only minor increases expected in the coming years. Wage growth, after a significant post-2022 rebound, has been moderating but remained high at 4% in the 2025 third quarter, with the ECB’s wage tracker indicating growth in the 2.5%–3% range for next year. This should keep real disposable income growth at or above 1%, making it a crucial driver of GDP. A high savings rate remains a risk to the expected consumption strength. However, we see a normalization of factors like low consumer confidence, high interest rates, food inflation, and geopolitical uncertainty potentially leading to a slight decrease in the saving rate.
• Investment activity is expected to improve as financing conditions ease and uncertainty fades. Past monetary policy easing continues to filter through, with borrowing costs declining and credit creation—especially for housing—picking up. Although economic policy uncertainty is still high in Germany, it is expected to decline while public investment is likely to rise, driven by defense and infrastructure spending. However, policy uncertainty appears likely to remain in France amid the upcoming elections.
• Fiscal policy in the euro area should remain broadly neutral to mildly supportive, with some variation across countries. The European Commission estimates a neutral stance overall, but this includes ambitious structural adjustments in France that may be overly optimistic. Germany stands out, with fiscal spending ramping up as new budgets and special funds become operational. Initial data show increased borrowing, especially for infrastructure, though actual spending may lag targets. There is some caution about whether Germany will fully deliver on its ambitious plans, but delays do not necessarily signal failure, and market sentiment may be too pessimistic.
• Euro-area exports have shown resilience, even as exports to the United States have declined and volatility persists. Overall exports remain robust, with improvements outside the United States and China. However, competition from China is a growing concern, as China’s export share rises and import intensity falls, particularly affecting sectors like autos and chemicals. This trend is a gradual, long-term headwind rather than an immediate threat.
• Inflation is expected to average below the ECB’s 2% target in 2026, mainly due to weak energy prices and a stronger euro. Disinflation in services is likely to persist, with wage moderation being a key factor. However, some risks remain, such as stickier wage growth and potential methodological changes in inflation measurement. The GDP deflator is running at 2.4%, with unit profits offsetting declining labor costs. The delay of the carbon pricing mechanism program (ETS2) will likely postpone the inflation impact until 2028.

With the deposit rate at the midpoint of neutral estimates, the ECB appears to be in a comfortable position. The focus is on inflation and growth outcomes, and with inflation near target and growth resilient, the bar for rate cuts remains high. We believe the ECB is likely to wait for more data before making any moves, and “insurance” cuts seem quite unlikely. A rate hike in 2026 also seems too early to price, but risks might rise if growth or inflation surprises on the upside; however, this would not likely prompt a full hiking cycle.

• Growth—expansionary fiscal policy to keep economy afloat: Preliminary third quarter 2025 GDP figures fell a 1.8% quarter-on-quarter (q/q) seasonally adjusted annual rate (saar), versus expectations of -2.4% and our own estimate of -0.4%. The sharper decline was mainly due to a higher-than-expected drop in residential private investment (32.5% q/q saar) linked to regulatory changes—expected to be a one-off. Despite this, private consumption rose 0.6% q/q saar, the sixth straight quarter of increase, and business investment was robust at 4.2% q/q saar. AI-related tech demand is contributing to capital expenditure. Net trade, however, subtracted from growth as exports contracted faster than imports. The GDP deflator rose for the 12th straight quarter, and unit labor costs increased, indicating entrenched inflationary pressures.

• High-frequency indicators in the third and fourth quarters suggest a positive trend: September core private machinery orders rose 4.2% month/month seasonally adjusted, with a notable increase in AI-related sectors. The all-industry flash purchasing managers index was up, and manufacturing sentiment has been improving, while services remain steady, pointing to robust underlying growth overall. Our 2025 GDP forecast has been upgraded due to earlier revisions and expectations of a strong fourth quarter, with 2026 forecasts unchanged for now. The new administration under Prime Minister Takaichi has moved toward fiscal expansion, with higher spending plans for next year’s budget, creating market contradictions—weaker yen and higher long-term yields—as policy easing and higher inflation collide.

• Policy support should keep growth resilient through 2026: On November 21, the Cabinet approved an economic stimulus package of ¥21.3 trillion (3.2% of GDP), with ¥17.7 trillion in additional government spending—the largest since COVID-19. The package targets inflation (tax cuts, subsidies, grants), growth investment (semiconductors, AI, shipbuilding, space, resilience), and defense. The government estimates this will add ¥24 trillion to real GDP next year, raising the annualized growth rate to 1.4%. This has already buoyed sentiment with consumer confidence improving in November.

• Net exports remain a drag, especially to the United States, with most export categories weak except for semiconductors, which benefit from global AI demand. Domestic demand, led by policy, is likely to steer growth in 2026 and 2027.

• Inflation—beyond supply risks: Underlying inflation should turn in more structural, with forecasts for inflation to average close to 3% in 2025, above BoJ and market consensus. Government subsidies should continue to depress inflation in 2026, with measures like energy subsidies and free tuition likely to reduce the core Consumer Price Index by 0.4-0.5 percentage points. Public services costs have remained flat, but price revisions are expected in 2026, which could impact service inflation.

• Wage growth—stabilizing at high levels: Japanese Trade Union Confederation (Rengo) set high targets for next year and minimum wages were raised 6% from October. While hard wage data is volatile, scheduled earnings are at their highest in decades. Structural reforms, such as the new Subcontract Act, aim to support wage growth, especially for small and medium-sized enterprises.

• Core inflation is expected to soften in the first half of 2026 due to subsidies, but remains above the BoJ’s 2% target through 2027.

• BoJ—we expect a December rate hike: Based on our growth and price outlooks, we therefore firmly believe the BoJ will have to progress on its rate tightening trajectory to not risk further weakening in the yen. This path would take the policy rate to 0.75% by year end-2025, with further hikes in 2026 and a terminal rate of 1.50% in 2027. The main risk is a downward movement in inflation expectations. The yen’s outlook is complicated by government stimulus and slower central bank hike risks.

Currency outlook

US dollar (USD)

• Dollar weakness is not quite finished. Although the trade uncertainty driven shock to the dollar in the first half of the year has faded and US growth has thus far proven resilient, we think structural factors—such as balance of payments (BoP) dynamics, the potential for equity outflows given lofty valuations, and unsynchronized monetary policy cycles—could weigh on the dollar. Despite the 10% drop in the first half of the year, the dollar remains significantly overvalued. The clearest evidence of overvaluation we see is the widening US current account deficit, which appears to have breached the critical 4% of GDP threshold; this has typically weighed on the USD.

• Thus far, the United States has had no problem financing its current account deficit thanks to massive portfolio inflows. The United States stands out among its G10 peers for attracting a large amount of both equity and debt inflows over the past year. However, sustaining these flows could prove to be a challenge given global investors’ already heavy exposure to US equities. With countries like Germany, China and Japan motivated to ease fiscal policy to bolster domestic demand, global capital will have alternatives. US equities may come under pressure, especially if the United States is no longer believed to be as exceptional an investment destination. Japanese pension funds have already begun to show signs of rebalancing—selling foreign equities as they rise, and reallocating to fixed income.

• Foreign demand for US debt may begin to soften as well. Japan is also showing a rising inclination toward European bonds. Moreover, market expectations for further cuts have shrunk the US’s yield premium. Most US peers will likely see rates stabilize or climb, while market expectations are for US growth exceptionalism to fade as other developed market peers catch up.

Euro (EUR)

• The EUR should keep its mildly constructive backdrop, supported by a gradual improvement in sentiment and a favorable domestic economic environment. We believe market pessimism—often tied to Germany’s perceived inability to deploy fiscal resources—should ease as spending becomes more visible next year, even if France’s political uncertainties remain a lingering drag. Moreover, as growth in the euro area gradually converges toward that of the United States in the second half of 2026, the cyclical narrative should shift in favor of the EUR, in our view. The ECB is likely to remain on hold throughout the year, with inflation sitting close to 2% and activity showing signs of firming, reducing the risk of monetary policy divergence. Meanwhile, flows into euro-denominated sovereign debt have remained consistently positive since April, with foreign investors continuing to accumulate European government bonds. Although the pace of inflows has not accelerated materially, their stability reflects increasing confidence in the region’s role in diversification of global portfolios.

• However, we remain cautious about the euro’s ability to deliver sustained appreciation in early 2026, particularly given a still-supportive backdrop for the US dollar. Growth tailwinds in the United States should become more visible in the first half of the year as fiscal measures gain traction, limiting the extent of USD weakness. In addition, we expect the Fed will be unable to cut rates all the way toward the 3% level markets are currently pricing in, thereby preserving part of the USD’s yield advantage. These dynamics suggest to us that while the euro’s medium-term fundamentals are gradually improving, relative growth and rate differentials could constrain near-term performance. A broader reallocation into non-US assets—particularly as valuation and BoP considerations come to the forefront—could support the currency later in the year, but the near-term balance of risks keeps us measured in our optimism.

Japenese yen (JPY)

• The yen has been on a downward trend since hitting a high of 140.8 in April this year. This weakness was largely due to the central bank’s reluctance to raise rates in line with rising inflation and inflationary expectations. Although there was a pause because of tariffs and related uncertainty, the BoJ’s tone shifted toward more hawkishness once it was clear the economy was holding up. However, when the new government came into power, it seemed to cause the BoJ to reconsider.

• Broader weakness was seen since new Prime Minister Takaichi took power in October, as markets considered higher fiscal stimulus and the possibility the BoJ would step back from hikes. The latter was evident in October when the BoJ kept rates on hold and Governor Ueda sounded more dovish. Governor Ueda’s latest comments in early December, however, have almost made a December move certain, which we long believed in. Most market participants have moved toward our call, and the yen has partially gained ground since.

• We believe the yen should gain as it is the only major central bank raising rates while others are on hold or cutting rates. The US dollar/yen has now overshot yield differentials, even those that led to the Ministry of Finance’s intervention in 2024. With the Fed’s interest-rate cut at the December FOMC meeting and more BoJ hikes likely, we expect the pair to correct lower, though breaking below 150 in the near-term seems unlikely given expectations of fiscal expansion.