Fed: AI-driven growth complicates rate path – NBC

National Bank of Canadas (NBC) Senior Economist Jocelyn Paquet, argues that surging AI-related investment is keeping U.S. GDP growth above potential, with forecasts of 2.4% in 2026 and 2.0% in 2027. However, Paquet warns this strength, combined with a dovish Federal Reserve (Fed) stance, risks delaying a return of inflation to the 2% target and is reshaping expectations for USD rates.

AI boom sustains growth and inflation

“Is this a problem？ In the short term, the answer to this question is probably no. With hyperscalers projecting up to $800 billion in AI-related spending by 2026, growth in the sectors mentioned above is more likely to accelerate in the future rather than slow down, and economic data tends to confirm this hypothesis.”

“These developments lead us to believe that the worst may be over for households and that consumption growth could accelerate as the year progresses. If our forecasts hold true, household resilience and continued growth in AI-related spending should allow GDP growth to remain above its potential in the coming quarters.”

“The only problem with this scenario is that it may prove incompatible with a return of inflation toward the 2% target. Already in the first quarter, while consumer demand remained fairly weak, the core personal consumption expenditures (PCE) deflator rose at its fastest pace since the first quarter of 2023 (+4.3% on an annualized basis), pushing the 12-month rate to a two-year high of 3.1%.”

“Could the resurgence of inflation jeopardize the expansion by prompting the Federal Reserve to adopt a more restrictive monetary policy？ The upward shift in energy prices—not only in spot markets but also in futures markets—has certainly made the possibility of policy rate cuts this year much less likely, as evidenced by the OIS markets.”

“Whether or not one agrees with the central banks current (and likely future) stance, monetary policy should nevertheless continue to stimulate the economy. This is partly why we forecast real GDP growth of 2.4% and 2.0%, respectively, in 2026 and 2027. But this combination of above-potential growth and lenient monetary policy will also, in our view, delay the return of inflation to target, particularly if the conflict in Iran were to drag on.”