Global Economic Overview – May 2026

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The ceasefire in the Middle East remains extremely fragile. There is still optimism though that a deal will be reached in the near-term, resulting in the eventual reopening in the Strait of Hormuz and a gradual decline in energy prices, which forms the basis of our central case. But events over the weekend have reinforced the need for caution as the outlook can change very rapidly. Indeed, last weekend (23 – 24 May) started with reports of real progress towards a deal but since renewed US military attacks in Iran have taken place. When it comes to negotiations, points of contention between the two sides remain, such as the release of frozen Iranian assets, tolls to pass the Strait of Hormuz, and Iran’s stockpile of enriched uranium. 

Chart 1: S&P500 reaches record highs, helped by hopes of a peace deal



Source: Investec Economics, Macrobond

For the global economy the unblocking of the Strait of Hormuz remains critical, given its strategic importance in supply chains, particularly that of oil and gas. For now, despite the extensive cut in supply from the Gulf, wholesale energy price rises have been contained by the extensive inventory build-up before the crisis. But as Chart 2 shows, these inventories are being run down at a rapid rate. The concern is that peak summer demand for fuel is going to hit dwindling stocks, resulting in a spike higher in prices. The IEA is calling this the ‘red zone’ which it predicts could be in July or August if the Strait of Hormuz remains effectively closed. The clock is ticking. 

Chart 2: The IEA oil report provides an indication as to the state of global oil demand and supply 



Source: IEA Oil Market Report May 2026

The global economy does seem to be holding up well in the face of an increase in prices and greater uncertainty though. Indeed, as Chart 3 shows, the economic data continue to surprise to the upside. One slight warning signal though was monthly activity figures from China in April, which were soft. However, there were some special factors at play. For example, retail sales growth was weighed down by unfavourable base effects, with the trade-in scheme unable to produce the same boost to spending as it did last year. Flash PMIs for May globally were on the whole also a touch weaker, but point more to a slowdown in activity, as we already had pencilled into our forecasts, rather than a severe economic shock. 

Chart 3: Global economic data continues to exceed expectations



Source: Investec Economics, Macrobond, Citi

Our global growth forecasts are little changed at 3.0% this year and 3.1% next. However, the risks lie to the downside. If, in the absence of a deal, traffic through the Strait remains at a standstill longer-term, shortages in certain products will begin to bite. Here either prices will need to rise further or demand suppressed; or likely a mix of both. But even if we do reach a swift conclusion to the conflict, it will take months to get flows out of the Strait back to normal. Worse still, the risk that military action resumes is by no means off the table, as demonstrated last weekend. This could result in greater damage to energy infrastructure across the Gulf and deepen the energy price shock, and its macro implications. 

Chart 4: Our GDP forecasts are little changed, but risks are tilted towards the downside 



Source: Investec Economics

At least part of this risk will have been priced into sovereign bond markets, which have seen a sharp sell-off since the conflict began as investors digested the potential inflationary and monetary policy impact of the Iran conflict. This is most clearly seen in the rise in 2y yields, but 30y bonds have also taken a hit, albeit to a smaller extent (Chart 5). At this longer maturity, the moves are unlikely to be just about short-term inflationary or policy rate pressures. There is also a term premium argument, where investors demand higher returns to hold longer-term assets. This is hardly surprising in a world that has become more fragmented, requiring higher defence spend and greater pressure on fiscal deficits. 

Chart 5: Government bond yields have risen across the curve – more so at the short end



Source: Investec Economics, Macrobond

For central banks the rise in bond yields and corresponding tightening in financial conditions is doing some of their job in counteracting inflationary pressures. Given this, and considering the vast uncertainty, most central banks are opting to wait-and-see how the situation in the Middle East evolves before rushing to raise rates. The notable exceptions to this are the RBA and Norges Bank. These are two interesting cases. Firstly, Australia had already started lifting rates before the conflict started, and secondly, both are net energy exporters. This might sound counterintuitive, but as both are also global price takers, it does not shield them from higher inflation, but it does increase the risk of the economy overheating, necessitating higher rates. 

Chart 6: Wait-and-see appears to be the favoured policy move from central banks 



Source: Investec Economics, Macrobond

United States

US GDP figures have undergone numerous gyrations over the past year or so, not least as President Trump's tariffs have resulted in volatility in imports and inventories. A smoother gauge of underlying demand is the Fed's favoured measure of 'real private domestic final purchases' (i.e. consumption plus private fixed investment). ‘RPDFP’ slowed through last year, but not abruptly, with year-on-year growth standing at 2.5% in Q1 this year. Prospects for Q2 look robust, buoyed by record rebates from Trump's One Big Beautiful Bill Act tax cuts, but this support is likely to be temporary with higher energy costs becoming the predominant driver of consumption in H2. We have lowered our GDP forecasts marginally to 2.0% this year and 1.8% next.

Chart 7: Underlying demand has slowed since the start of last year



Source: Macrobond, Investec Economics

While the inflationary impact of tariffs had shown signs of waning in recent months, energy related price pressures have pushed inflation rates up again - the annual rate of headline PCE inflation was recorded at 3.5% in March (and the core measure at 3.2%). From the perspective of the FOMC, we would note that both the headline and core rates have now been running above the Fed’s 2.0% objective for five years (Chart 8). But in the absence of another major surge in energy costs, both measures should ease by end-year. Note that unit labour cost growth has been moderating – in Q1, it stood at 1.2% y/y - and a slower economy should help to keep a lid on any firmer wage pressures, helping to keep inflation on track to meet its target over the medium-term. 

Chart 8: Headline and core PCE inflation have exceeded the Fed’s 2% objective for five years



Source: Macrobond, Investec Economics

Kevin Warsh has taken over at the helm of the Fed. This was after last month’s FOMC meeting kept the Fed funds target range on hold at 3.50%-3.75% and saw four dissents, the most since Oct 1992. Former Chair Powell remains a Governor for now and so temporary Governor Miran, who favoured a 25bp cut, has left his post. The three other dissenters (Hammack, Logan and Kashkari) preferred to remove the easing bias in the committee’s statement. Also, subsequently the minutes showed that most members believed higher interest rates would be warranted if inflation were to continue to run persistently above its objective. Amid the many uncertainties, we stand by our baseline view that the … 

Chart 9: April’s FOMC minutes were relatively hawkish



Source: Federal Reserve, Investec Economics

… FOMC will maintain its steady stance this year and loosen policy in 2027, if inflation pressures are waning sufficiently. Trump seems to be putting less pressure on Warsh to cut rates than he did on his predecessor, stressing he wants ‘Kevin to be totally independent’. We await what a Warsh Fed has in store. For one, he has pledged to end forward guidance. Another key aim is to reduce the size of the Fed’s balance sheet, which he has described as ‘bloated’. But as we wrote in Feb, the risk is that the resulting lower level of bank reserves causes periodic volatility in shortdated rates, requiring Fed intervention to add liquidity. Note that the Fed launched the Reserve Management Program last Dec specifically to avert this situation.

Chart 10: The Fed’s balance sheet is below its peak but slimming it further may be complex



Source: Macrobond, Investec Economics

Odds for the midterms have shifted modestly towards the GoP recently. The Democrats are still favourites to recapture the House in Nov, but the odds have lengthened to 75% from 87% a month ago (Chart 8). This has occurred partly as the Supreme Court (SC) narrowed the scope of the Voting Rights Act in a Louisiana based case, giving the Republicans more scope to 'gerrymander' district boundaries to their advantage. This has encouraged GoP run Alabama and Tennessee to try to do the same. Meanwhile an attempt by Virginia Democrats to increase the number of 'blue' districts was rejected by the SC. The perceived chances of the Democrats flipping the Senate have similarly faded.

Chart 11: Political momentum has swung a little back towards the Republicans recently



Source: Macrobond, Investec Economics

As in other sovereign markets, Treasuries remain extremely sensitive to the situation in the Middle East. Short-term interest rate expectations have driven up 2y yields. But yields at the longer end of the curve have moved sharply higher too (Chart 12). This month the 30y Treasury yield hit 5.18%, the highest since 2007, as inflation fears mounted and bond markets priced in a higher-for-longer rate policy. Fiscal concerns may be playing a part too; with no medium-term consolidation in the US Federal deficit on the cards and with debt servicing continuing to rise. That said, we would expect bonds to rally on a resolution to the Iran-US conflict, as is our baseline view, and so  pencil in 10y Treasury yields ending the year lower at 4.25%. and 2027 at 4.00%.

Chart 12: Yields have moved higher across the Treasury curve 

 



Source: Bloomberg, Investec Economics 

Eurozone

Eurozone Q1 GDP growth proved to be weaker than expected, at least at the headline level, coming in at 0.1% q/q. But this partly owed to rounding and partly to a 0.08%pt drag from Ireland’s 2% contraction. Absent these, the figure would have been closer to our and the ECB’s estimates. Nonetheless the Iran conflict is likely to result in a soft economic picture in the near-term. A weakening in the consumer space is evident: confidence has dropped to levels last seen in 2022, whilst the services PMI is at its weakest since 2021. In contrast the manufacturing sector had looked to be bucking this trend, with the PMI having strengthened 1.4pts between Feb and Apr and output up 0.2% m/m in March. But this looks to temporary amidst… 

Chart 13: We expect some softening in GDP growth in the near term, but a rebound thereafter 



Source: Macrobond, Investec Economics 

…reports of firms frontloading orders ahead of expected supply chain issues and price rises, similar to the situation ahead of Trump’s Liberation Day tariffs last April. Indeed, May’s PMI pointed to this effect fading. Higher market interest rates and a tightening in financial conditions may also prove to be a headwind to activity with the ECB’s latest Bank Lending Survey reporting a further net tightening in credit standards in Q1. As such we expect GDP growth to average just 0.2% q/q over Q2 and Q3, before rebounding in Q4 as Middle Eastern pressures ease. Our ‘26 and ‘27 forecasts are unchanged at 0.9% and 1.7% respectively.

Chart 14:  ECB Bank Lending Survey: Lenders report a tightening in credit standards



Source: Macrobond, ECB BLS April 2026 

The impact on inflation is becoming evident too in a variety of metrics, from the PMI surveys to the 3.4% monthly increase in producer prices in March. But it is the rise in headline HICP inflation to 3.0%, its highest level since 2023, that matters for the ECB. Unsurprisingly energy prices played the predominant role, rising to 10.8% y/y. We see inflation increasing further to a peak of 3.5% in June. But on our assumption that the spike in energy prices is temporary, we would expect inflation to trend lower over H2 and into 2027. This though will depend on only limited indirect price pressures, which could lead to more persistent inflation. It is still early, but as yet these are not immediately apparent and the stability in the ECB’s wage tracker at 2.6% annual growth is encouraging.

Chart 15: Inflation in the Euro area will rise temporarily, but likely fall to 2% in the medium term



Source: Macrobond, Investec Economics

With ECB policy rates currently around neutral and inflation set to rise further, an interest rate rise next month looks highly likely. Discussions at the last meeting in April appeared to be less on the ‘if’ but rather the quantum of tightening. In this regard it is worth noting that the ECB’s baseline forecast set out in March, which saw inflation peak at 3.1%, was conditioned on the assumption of two hikes. Given inflation is moving towards the adverse scenario, this raises the question whether more than two hikes might be needed. We suspect the ECB will be cautious given the uncertainties over the conflict and raise the Deposit rate twice in Jun and Jul taking it to 2.50%, with any adjustment beyond that dependent on when the war ends. 

Chart 16: A 25bp hike in June seems nailed on, and we think a July hike is on the cards too



Source: Macrobond, Investec Economics

 

Meanwhile a ramp up in defence spending continues to be promised. The Commission touted the potential for €800bn to be unlocked, €150bn of this coming from the SAFE fund, which has been fully subscribed, and the remaining €650bn from activating the NEC*. But here we wonder if spending could fall short. Fiscal constraints are uneven across the bloc with not all countries willing to increase spending by the same degree. Even among the 17 countries which have activated the NEC, many are not maxing out the 1.5% of GDP limit on defence spending given the recommendations from the Commission (Chart 17). Joint EU borrowing has been suggested as a solution for greater bloc-wide involvement and faster deployment. 

Chart 17: The potential €650bn expenditure unleashed by activating the NEC* could fall short



*National Escape Clause: flexibility to increase defence expenditure outside fiscal rules by up to 1.5% GDP. Chart data based on the European Council recommendations in approving activation of the NEC. No data available for Greece or Czech Republic.

Source: EU Council, Investec Economics 

Joint EU bond issuance has been called for not just to facilitate defence expenditure, but to act as a European safe asset too. Voices from the ECB argue that a deep liquid EU debt market could gain traction from investors and act as an alternative asset to US Treasuries. One opponent though is German Chancellor Merz, citing constitutional constraints and warning against immense debt and high interest payments. Indeed, Germany’s fiscal expansion, alongside the fallout from the Middle East, has pushed its own borrowing costs up; 10y Bund yields rose above 3% this month. Although we forecast 10y Bund yields to fall to 2.75% by end-year on a US-Iran peace deal, we expect them to remain elevated at 2.75% by end-2027 too. 

Chart 18: Joint EU issuance is the 5th largest in the Euro area, but a far cry from UST market size  



*Stock of US debt in EUR using current exchange rate. Source: Macrobond, Investec Economics

United Kingdom

Price pressure in the UK is building as the Iran conflict boosts energy costs. Motor fuel prices are already up. Meanwhile, utility bills will rise by 13% in July, and on current gas futures, may increase further in Oct. This unexpected jump in inflation will hold back consumer spending power. But it must be seen in perspective: despite utility prices that are 43% higher than before the Ukraine war and petrol prices that are only 4% down, households had been spending a smaller share of their disposable income on energy pre-Iran conflict than they did in Q4 ‘21 (5.0% vs 5.9%; Chart 19). On our baseline assumptions for a swift end to the conflict, we calculate this share may rise to c.5½%. This would weigh on consumption, but much less than in '22/'23. Our GDP forecasts are 1.2% for ’26 and 1.6% for ’27.

Chart 19: Pre-war, households have been spending less of their disposable income on energy



Source: ONS, Macrobond and Investec Economics:

Expressed in CPI terms, we predict inflation to peak at 4% and then fall to sub-2% from Q3 ’27 in our baseline case. Note that the backwardation in oil & gas futures also seems to embed a prompt end to the war. Considering the weakening in the jobs market, signs of which are mounting, we still judge that, rather than hiking, the BoE may merely postpone cutting the Bank rate until ‘27. But risks lie to the upside. In an alternative scenario where the Strait of Hormuz blockades persist long enough to bring about a pinch point when the cushion of inventory drawdown of oil is exhausted, we illustratively calculate a peak in inflation of over 4.5% (Chart 20). If the probability of such an outcome rises, the MPC might well prefer to raise rates.

Chart 20: The peak in inflation is yet to come, but where that lies depends on the Iran conflict



Source: ONS, Macrobond and Investec Economics:

This though is not the only focus for UK markets. Domestic politics has moved into the foreground again as the dismal outcome for Labour in the local elections earlier this month has, not unexpectedly, put pressure on Starmer to relinquish his post as PM to another Labour politician. He has so far resisted. The challenger most likely to beat him in any leadership contest is Andy Burnham. But to be in the running, Burnham first needs to win the by-election in Makerfield on 18 June to re-enter parliament, which is by no means a given. If his bid fails, Starmer could therefore either stay in office or be replaced by Wes Streeting, who is seen as a relative centrist. 

Chart 21: Labour lost a lot of support in the ’26 local elections versus the ’24 General Election



Source: Rallings & Thrasher, Sky News, Investec Economics

By contrast, Andy Burnham is among the more left-leaning Labour politicians. The markets’ worry had been that, to boost Labour’s popularity with the public, a PM Burnham might embark on a fiscal spending spree funded by extra borrowing. At a time when fiscal metrics are much weaker than in recent decades (Chart 22), visibly higher interest rates might be needed to absorb additional debt issuance. This concern manifested itself in gilt market underperformance at a time when interest rates have been rising across the board in other markets too. To reassure markets, Burnham has committed to follow the current fiscal rules, which were last tweaked by Rachel Reeves. These have two key components: the current budget (PSNB ex-investment) should be in…. 

Chart 22: The UK’s public sector debt has risen materially and deficits are still high



Source: ONS, Macrobond and Investec Economics:

…surplus and public debt* as a share of GDP should be falling by the target year. This is currently FY’29/30, but that is a rolling target; it will be the third year of the OBR’s projections from now on. Just how tough a constraint these fiscal rules are is questionable: there is scope for claiming that hard choices will be made in future, even when it is clear these are politically undeliverable. But markets would likely punish gaming the rules, so Burnham’s promises have helped to ease jitters, at least somewhat (Chart 23). Still, amid the trend rise in yields, the first questions are being asked whether active gilt sales by the BoE to shrink the balance sheet into a falling market remain appropriate. Come the autumn, this may be a live issue again.

Chart 23: UK 10y bonds’ underperformance since the start of the war has eased a little lately



*Defined as Public Sector Net Financial Liabilities                                     Source: Macrobond and Investec Economics

The Iran conflict and UK politics have made a mark on sterling. That said, the year-to-date range of GBP’s trade-weighted FX rate has been fairly narrow, at 2.1%; at the same time last year, the range was 4.3%. That GBP has been more stable comes not least as other countries’ money markets have re-evaluated rate expectations in light of the Iran conflict too, and as a poor election outcome for Labour came as little surprise given polls. We forecast mild GBP gains from here, to $1.37 and $1.38 by end-’26 and end-’27 respectively. Against EUR we predict levels of 88p at each horizon as we see more downside risks to UK than to EUR policy rates this year than priced in.

Chart 24: If the BoE does not hike rates this year, this could cap GBP’s performance 



Source: Macrobond, Investec Economics 

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