The turn of the year brings a familiar ritual of forecasting for economists. In 2025, many were badly wrong. Despite fears of “liberation day”, the United States recorded its fastest growth in two years, while Britain quietly became the second-fastest growing major economy. For all the gloom in the forecasts, the data told a different story. Will 2026 be different?

The consensus is cautiously optimistic: growth will be resilient, inflation contained, and interest rates are expected to fall more deeply into “neutral” territory — neither stimulatory nor accommodative. US GDP growth is expected to hold at 2–2.5 per cent, perhaps even accelerating slightly. UK GDP is likely to remain resilient too, despite a weak second half of 2025, a pattern mirrored across continental Europe.

Gentle tailwinds are emerging after a volatile 2025. Global trade uncertainty — though still elevated — is easing, and inflation is set to slow meaningfully. The eurozone will see inflation dip below 2 per cent at the start of the year. The UK will move from having the strongest inflation in the G7 to among the lowest, as negative base effects and budget measures push consumer prices index inflation to about 2 per cent from spring onwards. A resolution of the Russia–Ukraine conflict could add a further drag to price momentum, raising disposable incomes and offering some welcome relief for households grappling with a prolonged cost-of-living squeeze. With household and corporate balance sheets generally healthy, discretionary spending could finally see a long-awaited uptick, potentially even lifting a lacklustre housing market.

Easing price pressures will also give central banks scope to pull policy back towards neutral. The US Federal Reserve looks poised to cut rates a little further, and markets will be watching how far it goes as a new chair takes the helm in late spring. The European Central Bank is “in a good position”, having brought its deposit facility rate to a neutral 2 per cent. The Bank of England may have more work to do: despite pre-Christmas hawkish signals, slack in the labour market and falling inflation point to at least a couple of quarter-point cuts in the near future. Striking the right balance will be the central challenge in 2026 — potentially the hardest test since the pandemic.

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Beneath the apparently benign macro picture, structural shifts are adding complexity. Artificial intelligence, digitalisation and automation are beginning to reshape labour markets in more subtle ways than simply raising unemployment. Demand is shifting across sectors and skill levels, hiring is becoming more polarised, and adjustment is occurring faster than wages and institutions can respond, complicating the task for policymakers. Moreover, the dust has yet to fully settle on the trade war as questions over how global supply chains are adjusting to higher tariffs and a retreat from globalisation linger.

Financial conditions are also a concern. US equity valuations sit near dot-com-era extremes, while in Britain they rival pre-financial crisis highs, leaving markets vulnerable to a sharp correction. The UK’s openness makes it highly exposed to global shocks, with stress in one market readily spilling across interconnected channels. Private credit, hedge funds and other non-bank financial institutions now play a far larger role in market liquidity than a decade ago, with far less transparency.

As the IMF and Bank of England have both warned, leverage outside the banking system can amplify shocks through margin calls, forced selling and sudden shifts in correlations — particularly in an environment of shrinking central bank balance sheets. Central banks’ efforts to trim excess reserves will therefore be under heightened scrutiny. The Fed ended quantitative tightening at the close of 2025 to avoid destabilising markets; the ECB continues its course of passive QT; and the BoE remains the most aggressive in both actively selling down its gilt portfolio while ceasing to reinvest any maturing bonds — walking a tightrope between liquidity risks and policy objectives as it continues to sell down its bond portfolio. A taper tantrum — reminiscent of 2019 — cannot be ruled out. In a tightly leveraged, complex system, even small reductions in reserves can amplify stress.

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Yet economics alone will not define 2026. Electoral pressures on both sides of the Atlantic are likely to test fiscal discipline and constrain policy choices. In the US, the Supreme Court is set to rule on the administration’s use of emergency tariff powers under the IEEPA — a decision that could limit executive authority, reduce effective tariffs and reshape trade flows.

More importantly, domestic politics will take centre stage, with US mid-term elections and Britain’s May local elections providing the first serious tests of incumbency. These outcomes will matter for markets and investors in the years ahead, potentially reshaping political landscapes. Fiscal policy has less room for manoeuvre than in past cycles. Higher interest rates have pushed debt-servicing costs sharply higher, narrowing the space for counter-cyclical spending just as political pressure for support grows. In Britain, debt dynamics remain finely balanced; in the US, persistent deficits are colliding with a bond market increasingly sensitive to supply. The result is an uncomfortable trade-off: governments may be tempted to spend to placate voters, but with less tolerance from markets for fiscal slippage.

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Taken together, the message for 2026 may be familiar, but the stakes are higher. Growth may be intact, and inflation tamed, yet the margin for error has rarely been thinner. Labour markets are shifting, financial vulnerabilities are resurfacing, central bank balance sheets are shrinking, and politics is once again encroaching on economic decision-making. Policymakers’ challenge is no longer simply how quickly to normalise, but how to navigate a fragile equilibrium without triggering the very instability they hope to avoid.

Sanjay Raja is chief UK economist of Deutsche Bank