Theme of the Day: IMF World Economic Outlook - Global Economy in the Shadow of War

Once again, the global economy is threatened with being thrown off course — this time by the outbreak of war in the Middle East at the end of Feb 2026. Over the past year, headwinds from higher trade barriers and elevated uncertainty have been offset by tailwinds from technology-related investment; accommodative financial conditions, including a weaker USD; and fiscal and monetary policy support. The Middle East conflict presents a significant counterforce to these tailwinds through its impact on commodity markets, inflation expectations, and financial conditions. Given the difficulty of underpinning in real time a consistent set of assumptions for projections, this World Economic Outlook (WEO) report presents a “reference forecast”— in lieu of the traditional baseline — predicated on the assumption that the war will have limited duration, intensity, and scope, such that the disruptions will fade by mid-2026, consistent with commodity futures prices as of March 10. However, given the fluidity of the situation, the report complements the global reference forecast with scenarios in which the conflict lasts longer or expands. The likelihood of these scenarios materializing rises progressively as hostilities and associated disruptions continue. Under the reference forecast, global growth is projected to be 3.1% in 2026 and 3.2% in 2027, slower than its recent pace of about 3.4% in 2024–25, and to settle at about that rate in the medium term, slower than its historical (2000–19) average of 3.7%. The forecast for 2026 is revised downward by 0.2 percentage point and that for 2027 is unchanged, compared with those in the Jan 2026 WEO Update. Global headline inflation is expected to increase to 4.4% in 2026 and decline to 3.7% in 2027, marking upward revisions for both years. Absent the war, global growth would have been revised upward. Indeed, forecasts based on pre-conflict assumptions would have shown a slight upward revision of 2026 growth relative to that forecasted in the Jan WEO Update, by 0.1 percentage point to 3.4%. Hence, the downward revision for 2026 largely reflects the disruptions from the conflict in the Middle East, partly offset by carryover from recent strong data and reduced tariff rates. Under an adverse scenario with larger and more persistent increases in energy prices, global growth would slow further to 2.5% in 2026, and inflation would reach 5.4%. Under a more severe scenario in which there is more damage to energy infrastructure in the conflict region, the impact would be even larger: Global growth would be cut to only about 2% in 2026, while headline inflation would be just above 6% by 2027. The impact on emerging market and developing economies would be almost twice that on advanced economies. Downside risks dominate, even after the realization of a risk event — namely, an escalation of geopolitical tensions — frequently underscored in previous WEO reports. Geopolitical tensions could worsen even more than they already have — turning the situation into the largest energy crisis in modern times — or domestic political strains could erupt. Political stress factors can get entangled with shifts in trade and other international policies. Independently of geopolitical developments, trade-related disputes could flare up. As the Commodity Special Feature highlights, the critical role of rare earth elements in global supply chains constitutes a particular point of friction. A re-evaluation of profit expectations regarding artificial intelligence (AI) or lowered expectations of viable markups stemming from more intense competition — even if productivity gains are realized — could lead to a decline in investment and trigger an abrupt correction in financial markets. Larger fiscal deficits and increasing public debt, starting from a position where fiscal buffers are already eroded, could put pressure on long-term interest rates and, in turn, on broader financial conditions. An erosion of institutions, including central bank independence and monetary policy credibility, could raise inflation expectations — especially at a time when headline inflation is increasing because of a shock in salient prices. On the upside, activity could be further lifted by AI-related investment and eventually transform into sustainable growth if faster AI adoption translates into strong productivity gains and increased business dynamism. Activity could also be supported by renewed momentum for structural reforms and by a sustained easing in trade tensions.