The Global Economy’s Tenuous Balance: Resilience Amid Uncertainty

A new Citi Research report from a team led by Global Chief Economist Nathan Sheets explores the global economy’s remarkable resilience despite mounting challenges, from the sustainability of the artificial intelligence (AI) boom to geopolitical tensions. 

The number of such challenges in growing. The U.S.-Iran conflict has pushed Brent crude to $115 a barrel, close to this year’s high. Concerns about the AI boom have intensified, while renewed worries over French fiscal performance have added to broader sovereign debt pressures. Consumer and business confidence indicators remain subdued, with households particularly pessimistic.

Yet despite notable and apparently increasing headwinds, we now expect global gross domestic product (GDP) growth of 2.7% this year, slightly stronger than last month’s forecast and broadly in line with our expectations at the start of the year. Developed markets are performing somewhat better than we anticipated in December, largely because of continued U.S. strength. Meanwhile, emerging markets remain slightly softer overall, as stronger growth in Asia is nearly offset by weaker outcomes in the Middle East and Africa. We expect global growth to climb to 2.8% next year.

Recent Purchasing Managers’ Index (PMI) readings reinforce this picture. Global manufacturing activity has continued to strengthen, supported by the electronics sector and AI-related investment. Sharply rising U.S. investment has boosted production and technology exports across other regions, especially in Asia. Economies with significant exposure to AI, including Taiwan and South Korea, have posted strong growth despite their vulnerability to higher oil prices.

The services sector has also remained resilient. After weakening during the early phase of the U.S.-Iran conflict, the global services PMI has rebounded. Labor markets remain firm, hiring has held up, and consumption continues to grow. Despite consumers’ caution, spending hasn’t materially slowed. Citi’s global Surprise Index similarly suggests that economic data continue to exceed expectations, while China has improved modestly and euro-area data have moderated.

The key takeaway is that it will likely require a substantially larger shock to derail global growth. For now, businesses continue to adapt effectively to changing conditions, helping sustain expansion despite mounting risks.

Inflation, however, has become a more significant concern. Since February, oil prices have risen roughly 60%, while jet fuel prices are up 100% and diesel prices 110%. As a result, we expect global headline inflation to reach 3.4% this year, compared with 2.8% last year, before easing to 3.0% next year provided that oil prices moderate.

Core inflation pressures have also intensified. Higher transportation costs and disruptions to supply chains — particularly in aluminum, petrochemicals and fertilizers — are gradually feeding through to consumer prices. We now expect core inflation this year to be at least 0.5 percentage point higher than we projected in February for economies including Brazil, Australia, South Korea, the euro area and Thailand. Central banks are increasingly moving toward tighter policy stances.

A notable consequence of this environment has been rising sovereign bond yields. Since the U.S.-Iran conflict began, 10-year yields have increased by 175 basis points (bp) in France, more than 100 bp in both the U.S. and the UK, and 75 bp in Japan, Germany and Canada. Several emerging markets have also experienced rising yields, including the Philippines, Indonesia and India.

We attribute these moves partly to growing competition for global savings. U.S. Treasury issuance is likely to remain at $2 trillion or more annually, financing needs elsewhere are substantial, and AI investment is emerging as another major consumer of capital. Global AI-related capital expenditures are projected to exceed $3.5 trillion by 2030. At the same time, investors are demanding greater compensation for geopolitical uncertainty, fiscal risks, inflation volatility and governance concerns, contributing to higher term and risk premiums. We also see oil-market volatility as playing a role.

France remains a particular source of concern. Even under relatively favorable assumptions, rising interest costs are likely to keep budget deficits near 4% of GDP, while government debt approaches 120% of GDP. Political uncertainty ahead of next spring’s presidential election has further undermined confidence. Encouragingly, pressures have largely remained contained, though Belgium and Italy have shown some sensitivity to French developments, and we continue to monitor potential spillovers to the UK.

On AI, we remain constructive. We view the current investment cycle as being driven by businesses seeking productivity gains and competitive advantage. For many firms, AI investment has become an imperative for survival. We expect this spending wave to persist well into the next decade, with meaningful productivity benefits beginning to emerge over the next two to three years.

That said, three risks warrant close attention. First, financial disruptions remain possible. As with the internet boom of the late 1990s, a transformative technology can generate bubbles, mispricing and failures. However, investors today appear highly alert to these risks, and periodic corrections may be reducing the likelihood of a broader speculative bubble.

Second, political support for AI appears to be weakening, particularly in the U.S. Concerns about electricity demand, power-grid capacity and job displacement have become increasingly prominent, raising the possibility of more-restrictive policies toward data-center construction and AI deployment.

Third, cyber risks are increasing alongside AI capabilities. More sophisticated cyberattacks or failures involving advanced AI systems could have significant economic and political consequences, potentially triggering stricter regulation.

Against this backdrop of resilient growth and elevated inflation, central banks have pivoted toward tighter policy. Across 27 major central banks, we now expect 16 to raise rates this year, six to remain on hold, and only five to ease policy. This marks a sharp departure from expectations earlier in the year, and we note that in contrast to the period after the pandemic, central banks have generally refused to “look through” the supply shock.

Looking ahead, we see a more mixed picture, with monetary policy remaining heavily dependent on oil prices and the trajectory of the U.S.-Iran conflict. We expect additional tightening from the Federal Reserve, European Central Bank, Bank of England, and Bank of Japan, although the outlook for 2027 appears more balanced. For now, central banks remain focused on preventing inflation from becoming entrenched, even as growth continues to prove more resilient than many expected.