With the US labour market not cooling more rapidly and as inflation remains above the Fed’s target, the US central bank is likely to be in a wait-and-see mode. The latest FOMC minutes continued to point to division among policy makers. We have pushed our expectation for the next Fed funds rate cut from March to June.

Selena Ling
Chief Economist & Head,
OCBC Group Research,
OCBC

The situation in the Middle East remains highly fluid, with ongoing conflict in Iran, uncertainty surrounding the succession process following the reported death of Supreme Leader Ayatollah Ali Khamenei and increasing caution around the Straits of Hormuz—a key chokepoint for global energy and trade flows. These developments have heightened geopolitical risk premiums and driven a flight to quality. The key question now is whether this conflict proves temporary or becomes more prolonged.

Historically, the economic impact of Middle East conflicts tends to be sharp and front‑loaded. The 1973 Yom Kippur War, which lasted roughly three weeks, triggered a major oil crisis after Arab members of OPEC imposed an embargo on the United States. The 1979 Iranian Revolution and the subsequent Iran–Iraq War from 1980 onward led to sustained production losses. In contrast, supply fears during the 1990 Gulf War eased relatively quickly, as was the case during the 2003 Iraq War and the 2019 Saudi Aramco attack.

Several factors will shape how the current Middle East situation plays out. The key considerations are whether physical supply is truly disrupted—given that the Strait of Hormuz handles about 20% of global crude oil trade, whether major producers like Saudi Arabia and the UAE have enough spare capacity to cushion any shortfall, the broader global demand environment (since weak economic growth tends to make price spikes fade more quickly), and the likelihood of a coordinated release of strategic oil reserves to ease short-term supply pressures.

United States

The US economy is projected to grow by about 2.2% in 2026, like last year’s pace. Historically, the labour market differential has moved closely with the unemployment rate.

Since the differential has only recovered modestly, it suggests no major weakening in overall labour conditions in the near term.

As a result, expectations for interest-rate cuts have been pushed back. Futures markets now expect the first Federal Reserve rate cut in July. We now anticipate the first cut in June instead of March, indicating that the Fed now needs a higher level of evidence before easing policy.

On trade, the US Supreme Court’s decision to reject President Trump’s tariff plan under the IEEPA has shifted the administration’s approach. In response, the US began implementing a temporary 10% global import tariff under Section 122 on 24 February, with officials indicating it could rise to 15%. Although the court ruling changes the legal basis for tariffs, the effective tariff rate is expected to be lower than what would have been imposed under the original IEEPA proposal.

In our view, this lower tariff impact could limit near-term downside risks to global trade, even though trade-policy uncertainty remains high.

Elsewhere, the delayed January US inflation data came in slightly stronger than expected, reinforcing the view that progress toward the Fed’s 2% target is likely to be uneven. Headline PCE rose 0.43% MoM, while core PCE increased 0.36%, marking a notable pickup from the 0.2% pace recorded in November. On a YoY basis, core PCE held at 3.0%, underscoring that inflation remains meaningfully above the Fed’s comfort zone and that disinflation may proceed more slowly than markets anticipated at the start of the year.

On the labour front, conditions remained broadly resilient. The unemployment rate fell marginally to 4.3% in January from 4.4% previously. Consumer sentiment also improved: the Conference Board’s consumer confidence index rose to 91.2 in February, with January revised up sharply to 89.0 from an initial 84.5.

That said, the underlying details suggest a more nuanced backdrop. The share of respondents indicating jobs were “hard to get” climbed to 20.6%, the highest since February 2021, even as the proportion viewing jobs as “plentiful” also increased to 28.0%. This pushed the labour market differential modestly higher to 7.4%. Taken together, these indicators continue to point to a K‑shaped economic environment—one where pockets of strength coexist with emerging softness across sectors and income segments.

From a policy perspective, outgoing Atlanta Fed President Raphael Bostic highlighted that potential labour market disruptions from AI adoption may structurally raise unemployment in ways that cannot be fully offset by lower interest rates. Several other Fed officials echoed a similar view, reinforcing that the Fed sees no urgency to adjust policy in the near term. With inflation still elevated and employment conditions generally steady, policymakers appear inclined to remain patient.

In essence, the latest data supports a gradual and uneven path toward lower inflation. While the economy continues to show areas of resilience, mixed labour signals and ongoing structural shifts point to a more complex backdrop. Against this environment, we expect the Fed to maintain a cautious stance and avoid rushing into policy changes.

Euro-Area

We maintain our 2026 GDP growth forecast for Germany at 1.1%, compared with 1.5% in 2025. Medium-term fiscal spending plans should continue to support domestic demand. The European Parliament also noted, following the recent US Supreme Court decision, that “the situation is now more uncertain than ever” and that a “key instrument” used in negotiations with the US “is no longer available.”

Despite this uncertainty, growth in 2025 proved resilient and headline inflation remained within the ECB’s 2% target range. We continue to expect the ECB to keep rates on hold throughout 2026.

The second estimate of Euro Area GDP growth for 4Q2025 was unchanged at 1.3% YoY and 0.3% QoQ (seasonally adjusted). Growth was supported mainly by Germany (0.3% QoQ, up from 0.0% in 3Q25), Spain (0.8%, up from 0.6%), and Cyprus (1.4%, up from 0.9%).

Employment increased by 0.2% QoQ in 4Q25 and 0.7% for the full year, highlighting continued labour-market resilience. Inflation pressures also remain contained, with headline and core inflation steady at 1.7% YoY and 2.2%, respectively, in January. Survey indicators for 1Q2026 suggest that growth momentum has continued. The ECB kept its policy rate unchanged at 2.00%, with President Lagarde reiterating that the ECB will “follow a data-dependent and meeting-by-meeting approach” when determining its policy stance.

Japan

The economy ended 2025 on a softer note. Real GDP grew just 0.1% QoQ (seasonally adjusted) in 4Q25, falling short of the consensus forecast of 0.4% and underscoring the fragility of domestic demand. Still, the full-year picture was more positive: the economy expanded 1.1% in 2025, recovering from a 0.2% contraction in 2024.

Japan enters 2026 with greater political clarity but lingering macroeconomic uncertainty. Equity markets have rallied on expectations of fiscal stimulus and structural reform. Meanwhile, inflation data has complicated the outlook. Tokyo CPI eased to 1.8% YoY in February, dipping below the BOJ’s 2% target for the first time in over a year. However, the slowdown was driven mainly by government utility subsidies rather than a broad softening in underlying price pressures.

The political landscape shifted significantly in February. Prime Minister Sanae Takaichi secured a historic election victory, becoming Japan’s first female prime minister and winning a strong postwar mandate. Her decisive win gives her room to advance a conservative agenda centred on increased fiscal spending, defence modernisation, and deeper strategic alignment with the United States.

Markets viewed the result as supportive of growth and stability. The Nikkei 225 jumped more than 10% in February, buoyed by expectations of fiscal support and reform.

Japanese government bond yields fell sharply across the curve. PM Takaichi has pledged “active but responsible” fiscal management while committing to reduce Japan’s debt-to-GDP ratio over time.

On the currency front, the yen stayed weak. The policy outlook has become more complicated following the nomination of two academics—Ayano Sato and Toichiro Asada, both widely seen as dovish—to the BOJ’s policy board.

China

China’s GDP growth eased to 4.5% YoY in 4Q2025, down from 4.8% YoY in 3Q2025, broadly in line with market expectations. For the full year 2025, the economy grew 5.0% YoY, meeting the government’s target of “around 5%.” Looking ahead to 2026, China may set its national growth target in the 4.5%–5.0% range. Compared with 2025, around 12 provinces have maintained their growth targets, while 18 provinces have either lowered their targets or shifted from specific numbers to target ranges. On aggregate, the weighted average of provincial GDP targets for 2026 is estimated at 5.0%–5.1%, slightly below the 2025 average of 5.3%, reinforcing expectations of a softer national goal next year.

In January, both the manufacturing and non-manufacturing PMIs slipped back below the 50-point expansion–contraction threshold, indicating that demand momentum remains fragile and firms are still cautious about expanding capacity.

On the property front, Shanghai’s Pudong New Area, Jing’an District, and Xuhui District have announced plans to acquire resale residential units for conversion into government-subsidised rental housing. Previously, such acquisitions focused mainly on unsold newly built units. The updated approach places greater emphasis on older, smaller apartments in core districts. Converting these high-yielding rental units into subsidized housing helps unclog the upgrade chain for homebuyers while meeting rising rental demand associated with the continued urbanization of permanent residents.

More importantly, the policy sends an early signal that price floors for older, smaller units in core urban areas may be starting to form.