Economic Outlook: Inflation and Interest Rates
The current economic environment is characterized by low inflation, which has led to a decrease in the urgency for central bank independence. The Federal Reserve is already cutting interest rates, and the latest inflation data suggests that this trend is likely to continue. December’s inflation rate was surprisingly low, and tariff-sensitive categories are experiencing price declines.
Inflation Expectations
James Knightley expects rate cuts in March and June, despite market predictions that easing will not occur before summer. The benign inflation backdrop is expected to continue throughout 2026, with rents and service components showing renewed disinflation. However, some investors believe that fiscal policy could lead to increased inflation later this year.
Fiscal Policy and Inflation
The White House is shifting its focus towards the cost of living, with plans to buy mortgage-backed securities and cap credit card rates. Additionally, backdated refunds for tax cuts on overtime and tips are expected to start landing soon. Tariff rebate checks are also a possibility, although the consumer response to government cash may be more muted than during the pandemic.
Geopolitical Factors
The Supreme Court’s looming ruling on the President’s use of emergency powers to impose tariffs could have a significant impact on the economy. A decision is expected soon, and most analysts predict that the White House will lose its appeal. However, the President may rebuild the tariff wall using other methods, and further tariff reductions are possible later this year.
European Economic Outlook
In Europe, a shift is emerging, with Germany’s "wall of money" starting to hit the real economy. Industrial orders are rising, and production expectations are improving. The approval of the 2026 budget is expected to accelerate activity, and the rapid ramp-up of domestic defence industry capacity may challenge earlier assumptions about Europe’s extra defence spending.
Conclusion
In conclusion, the current economic outlook is characterized by low inflation and decreasing interest rates. While fiscal policy and geopolitical factors could lead to increased inflation later this year, the benign inflation backdrop is expected to continue throughout 2026. The European economic outlook is also improving, with Germany’s economy expected to grow in 2026 and 2027. As the year progresses, it will be essential to monitor these factors and their impact on the economy, and investors should be prepared for potential changes in the economic landscape.
