BIS Annual Report AI Scenarios

I. Progress and peril

I. Progress and peril

BIS Annual Economic Report |

28 June 2026

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33 pages

Chapter I: Data behind the graphs

Press release: Global economic pressure points call for policy discipline: BIS

Key takeaways

The global economy displayed surprising resilience despite successive shocks, from tariffs to the Middle East conflict. This was partly driven by optimism around progress in artificial intelligence (AI), which fuelled large AI-related investments and sustained accommodative financial conditions.

But the perils have grown with pressure points around risks of persistent inflation, the sustainability of AI-related investments, growing financial vulnerabilities and weakening fiscal positions.

Safeguarding price stability, restoring fiscal space, strengthening financial stability beyond the banking perimeter and structural reforms are key priorities. Discipline in each area expands the room the others have to act.

Resilience tested

The 12-month period under review falls into two phases. The first was one of surprising resilience. Global growth and trade held up despite the sharp tariff hikes, supported by easy financial conditions and strong artificial intelligence (AI)-related investment and sentiment. With a few exceptions, most notably the United States and China, inflation stabilised at, or was converging to targets, paving the way for policy easing in many jurisdictions. These benign macroeconomic conditions were, however, jolted by the conflict in the Middle East in late February 2026. In this second phase of the review period, the ensuing crisis of energy supply and other raw materials, following the historic closure of the Strait of Hormuz, cast shadows over the global outlook.

A resilient start

The global economy absorbed the sharp hikes in US tariffs during 2025 – the most significant disruption to the multilateral trading system in decades – with remarkably little damage. Global trade continued to expand, with merchandise volumes growing nearly 5% in the first half of 2025, despite skyrocketing trade policy uncertainty. Growth forecasts, initially cut sharply in response to tariff news especially for the United States, were subsequently revised upward to pre-April 2025 levels (Graph 1.A). The upward revisions were observed in both advanced economies (AEs) and emerging market economies (EMEs) (Graph 1.B). In China, robust exports helped sustain growth despite real estate overhang and subdued domestic demand. By end-2025, global growth ended up close to pre-tariff expectations. Reflecting this underlying resilience, analysts expected output to expand steadily across most jurisdictions, if slower than past averages (Graph 1.C).

Three main factors can explain the relatively muted effects of tariffs. One is their smaller than expected size. Because of exemptions, trade agreements and measured responses from trading partners that averted escalation, the effective average US tariff rate stabilised at 10% in the second half of 2025, significantly lower than the peak announcement of more than 25% (Graph 2.A). Accounting for this lowers the global output loss by about a third from initial estimates (Graph 2.B, red bars).

Graph 1

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Second, trade realignment also mitigated the impact of tariffs. In the case of China, the sharp fall of US-bound exports was compensated by higher exports to other parts of Asia, reflecting substitution and transshipments (see Box A on the adaptability and potential vulnerability of global supply chains). Moreover, China's increased competitiveness in higher value added goods, whose exports grew by 13% in 2025, also helped propel its overall exports.

Third, faced with the prospect of higher tariffs, firms adapted their trading strategies. Significant front-loading of trade before tariffs took effect cushioned both exporters and importers. At the same time, US firms accepted compressed margins, which temporarily limited the price pass-through. Estimates for US firms suggest those most affected by the tariffs absorbed about two thirds of the cost increases through lower profits, while only passing on one third to consumers (Graph 2.C). To manage higher trade policy uncertainty, firms may have delayed passing through higher import prices that would have been difficult to reverse.

Graph 2

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In addition to the tariffs' weakened effects, AI optimism provided an important tailwind to global growth through capital expenditure (capex) and associated intermediate goods trade. Capex in semiconductor purchases, data centre construction and expansion in power infrastructure surged in the United States, driven by the so-called hyperscalers (Graph 3.A). This spending provided impetus to aggregate investment, which became an important driver of growth surprises in the United States (Graph 3.B). The rest of the world, notably Asia, also benefited from demand spillovers through AI supply chain linkages, from semiconductors to data storage units and digital infrastructure (Box A). In China, investment rotated from the property sector to advanced manufacturing. In Europe, investment helped offset tepid consumption amid weak household confidence.

Monetary policy easing provided further support to economic activity in this first phase. With benign growth and moderating inflation, most central banks had lowered interest rates from restrictive to near-neutral levels, where many have paused since late 2025. In a few exceptional cases, central banks hiked interest rates including in Japan due to low real interest rates, and in Australia and Colombia because of domestic inflationary pressures. Meanwhile, central bank balance sheets remained large in key jurisdictions.

Accommodative financial conditions were also a key factor supporting growth during this phase. Financial conditions eased throughout 2025 (Graph 3.C), as the strong surge in global risk appetite fuelled by AI optimism dominated the effects of trade policy uncertainty. Global stocks enjoyed strong rallies on robust corporate earnings, led by major technology and AI-related stocks. Rising equity values, whose ratio to income has more than doubled since 2010, in turn supported household consumption through wealth effects. Corporate credit spreads continued to narrow in major jurisdictions, with robust primary issuance across the ratings spectrum and record volumes from AI-related firms. Investors' risk appetite was also evident in the private credit space, which contributed to the financing of AI infrastructure build-out.

Graph 3

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The conflict and its peril

The start of the conflict in Iran in late February 2026 and subsequent escalation – including attacks on energy infrastructure across the Persian Gulf and the effective closure of the Strait of Hormuz – posed a renewed threat to the global outlook. In early March, the unprecedented blockade of the world's most critical energy chokepoint brought the Strait's traffic to a standstill (Graph 4.A). The supply disruption was historically large in terms of volumes lost, with a cut in crude oil flow of over 10 million barrels a day, equivalent to 13% of normal supply (Graph 4.B). By comparison, supply losses in the 1970s energy crises were around 8%. That said, oil prices increased proportionally less than in previous crisis episodes, cushioned by oil reserve drawdown and market participants' conviction that the crisis would prove short-lived.

The prolonged disruption to Strait of Hormuz traffic could have persistent global stagflationary effects, given the Strait's vital role. Past interruptions have weighed on global industrial production and lifted global inflation for a sustained period even after their resolution (Graph 4.C). Compounding the supply disruption this time was the severe lack of immediate substitutes. Bypassing the Strait of Hormuz offers only partial offsets – the Saudi East-West pipeline to Yanbu on the Red Sea can reroute five million barrels a day at most for exports and is itself exposed to attacks. The strategic reserve release of 400 million barrels by the International Energy Agency (IEA), the largest in history, covered only 20 days of lost Hormuz flow.

Graph 4

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Asia bore a disproportionate brunt of the Strait's closure. Before the conflict, over 80% of crude and natural gas transiting Hormuz was destined for Asia. Japanese refiners sourced 95% of crude from Gulf states, with 70% shipped through Hormuz (Graph 5.A). Malaysia, Korea and Thailand imported between 60 and 70% of their oil from the Gulf, leaving them similarly exposed to Hormuz closure. Consistent with this, model-based estimates point to significant output losses across Asia, with the euro area also exposed through its reliance on distillate imports from the Gulf (Graph 5.B).

The breadth of the supply shock extended well beyond oil and gas, also affecting fertilisers, petrochemicals, plastics and other critical inputs. The Middle East accounts for around a third of global seaborne exports of liquefied petroleum gas, fertilisers and helium – and close to half of seaborne sulphur, a key fertiliser input. Petrochemical plants in South Korea, Japan and Chinese Taipei faced curtailments as both key feedstock (naphtha) and liquefied natural gas (LNG)-dependent electricity were simultaneously constrained. Fertiliser shortages could have persistent effects on global food supply, as missed planting windows cannot be recovered and weaker harvests constrict the next cycle of working capital. Food insecurity impacts would be most acute in low-income economies.

Graph 5

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Physical damage to energy infrastructure means supply losses are likely to persist even after the end of the conflict. By late March, more than 40 energy assets across nine Middle Eastern countries had been severely damaged. In Qatar, damage to LNG facilities cut capacity by 17%, with full recovery expected to take up to five years. Equipment bottlenecks compound the problem, with producers of gas turbines needed for LNG compressors carrying order backlogs of three to five years. Even without a blockade, global oil and gas supply could remain well below pre-conflict capacity for months or even years.

The conflict shifted the perceived inflation and monetary policy outlook. Inflation compensation surged across core markets, particularly in Europe, given its greater exposure to energy supply shocks (Graph 6.A). With looming increases in inflation, market participants started to price in a tighter monetary policy stance across a broad set of countries (Graph 6.B). Central banks that were previously expected to ease or hold rates steady are now expected to raise them, including in the United States, the euro area, the United Kingdom and Canada.

The shift in inflation and policy expectations led to a material increase in nominal yields. The initial adjustment was more pronounced at the short end of the curve, leading to significant flattening in core sovereign markets. But as the conflict dragged on, expectations of higher-for-longer rates and concerns about the fiscal implications raised long-term yields (Graph 6.C). Unwinding in leveraged positions in the cash market may also have contributed to the yield rise, amid the increased presence of non-bank financial intermediaries (NBFIs) in sovereign bond markets (Chapter II). Nevertheless, real short-term rates declined as the nominal rate increase still fell short of the expected pick-up in near-term inflation.

Risk appetite in broader financial markets retreated at the outbreak of the conflict but later recovered strongly. Global equity markets declined 9% from late February to end-March 2026, with the S&P 500 index down 8% over the same period. However, the sell-off was contained relative to previous episodes, such as the 2025 tariff hike (19%), the 1990 Gulf War (17%) or the 1979 Iranian revolution (17%). Even

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