Central banks role in weathering the war

Source: Nida Al Watan

Global growth is expected to reach 3.0% in 2026 and 3.4% in 2027, down from the 3.5% average recorded during 2024–2025, with virtually no cumulative change compared to the forecasts published in the April 2026 World Economic Outlook. This modest slowdown reflects the impact of the war in the Middle East, which has been partially offset by stronger demand momentum in the global technology cycle, driven by advances in artificial intelligence and its wider adoption. The impact varies considerably depending on countries' exposure to the war and their position within the technology value chain. Energy-exporting countries outside the conflict zone are benefiting from favorable terms of trade, while economies participating in the technology-driven upswing are experiencing stronger activity even if they are net energy importers.

By contrast, economic activity is weakening in energy-importing countries with limited participation in the technology value chain, a group that includes many low-income nations. Global headline inflation is estimated to rise from 4.1% in 2025 to 4.7% in 2026, before dropping to 3.9% in 2027. These forecasts, which have been revised slightly upward from the April projections, suggest that the disinflation trend that began in early 2024 has come to a halt.

Positive risks in energy markets

The risks to the outlook have become more balanced than they were in April, but they remain tilted to the downside. The possibility of renewed conflict in the Middle East continues to loom, with the potential to intensify commodity price volatility, further disrupt supply chains, drive prices higher, and tighten financial conditions. A potential correction in technology-driven market expectations also adds to downside risks, while the erosion of policy buffers could amplify these threats. Upside risks stem from a faster-than-expected normalization in energy markets, stronger-than-anticipated investment in technology, renewed and sustained international cooperation that lowers trade barriers, and structural reforms that boost medium-term growth. Policy priorities include restoring price stability, supported by central bank independence and strong financial supervision, while rebuilding fiscal buffers and using fiscal tools cautiously through temporary and targeted support that preserves market signals. Structural reforms are essential to strengthen energy security, prepare economies for artificial intelligence, and promote domestic rebalancing. International cooperation should also be reinforced to ease persistent global tensions. Uneven momentum continues amid conflicting shocks. Global economic activity and the outlook are being shaped by two principal forces pulling in opposite directions: first, the negative supply shock resulting from the war in the Middle East; and second, the ongoing positive technology shock, reflected in the accelerating momentum of the global technology cycle, driven largely by advances in and the deployment of artificial intelligence.

The global economy as a whole has, so far, weathered the shock of war better than ever feared. Strong corporate earnings and the resilience of the global economy have helped mitigate the impact of the conflict in the Middle East on the financial system.

Financial conditions remain favorable but have improved further amid expectations of a de-escalation of the conflict. Corporate bond spreads have remained historically tight, while equity markets have strengthened since the publication of the April 2026 Global Financial Stability Report, despite an increase in market-implied interest rates. More than 80% of companies listed on the S&P 500 exceeded earnings expectations in the first quarter of 2026, keeping the average price-to-earnings ratio at historically elevated levels, with only limited revisions to earnings estimates in interest rate- and energy-sensitive sectors. Stock market concentration in artificial intelligence-related equities—previously highlighted in the Global Financial Stability Report—has continued to increase, with stock markets that have significant exposure to AI, namely Japan, South Korea, Taiwan, and the United States, outperforming others during the second quarter of 2026. The risk of secondary effects from higher energy prices has led markets to price in higher interest rates through 2026, despite crude oil prices retreating from earlier peaks. Several central banks in both advanced and emerging economies have already raised interest rates. Long-term government bond yields have also increased globally, while uncertainty surrounding inflation could further exacerbate financial vulnerabilities, as noted in the April 2026 Global Financial Stability Report.

Energy-exporting countries outside the Middle East have experienced stronger currency performance, helping to contain inflation expectations and risk premiums. Portfolio investment flows into emerging markets have stabilized following the sharp decline recorded at the onset of the conflict. Investor appetite for hard-currency-denominated debt also remains robust, enabling several high-yield emerging markets to successfully issue international bonds.