Growth to Slow as Tariffs Bite, But AI Investments May Cushion the Blow

By Paul Hannon

The U.S. and global economies are set to slow next year as higher tariffs take full effect, but could grow more strongly than expected if the AI investment boom “broadens,” the Organization for Economic Cooperation and Development said.

In a quarterly report on Tuesday, the Paris-based research body forecast the U.S. economy will grow 2% this year and 1.7% next year, having expanded by 2.8% in 2024. In September, the OECD projected growth of 1.8% this year and 1.5% in 2026. It sees the world’s largest economy regaining momentum in 2027, with growth of 1.9%.

Despite that upgrade for its largest part, the global economy is still seen expanding by 2.9% next year, a slowdown from 3.2% this year. But the OECD warned that the slowdown could be more severe if new restrictions on exports of key goods such as rare earths and advanced computer chips were to be added to higher tariffs.

“A further rise in trade barriers, especially around critical inputs, could inflict significant damage on supply chains and global output,” wrote Mathias Cormann, the OECD’s secretary general.

The slight upgrade to the forecast for U.S. growth in 2026 reflects a recent decline in the effective tariff rate on imports following a series of agreements with countries around the world. The OECD now estimates the tariff rate at 14%, a sharp increase from 2.5% at the start of 2025, but lower than the 19.5% rate estimated at the end of August.

But even that lower rate has yet to entirely feed through to the economy, which is why growth is expected to slow.

“We don’t believe the full effect of tariffs have been felt,” said Asa Johansson, the OECD’s director for policy and research.

The OECD said higher tariffs will also ensure that inflation remains above the Federal Reserve’s target in 2026, averaging 3%. But it expects the inflation rate to fall back in 2027 as the impact on consumer prices wanes, and anticipates a “gradual” reduction in the Fed’s key interest rate to a range between 3.25% and 3.5% by end-2026, from 3.75% to 4% now.

While economic growth this year has been supported by the strong performance of equity markets, the OECD warned that could be reversed if revenues disappoint.

“High asset valuations based on optimistic expectations of AI-driven corporate earnings pose a risk of potentially abrupt price corrections,” Cormann wrote.

The AI investment boom has helped support U.S. economic growth this year, while also lifting countries with significant manufacturing of information and communication technology equipment, such as South Korea, Singapore, Japan and Taiwan.

The OECD said the global economy may grow more rapidly than it expects next year if that boom spreads to other large economies, such as those in Europe that have so far missed out.

“The strong momentum in AI-related investment in the United States could broaden to other major economies, boosting current spending and potentially raising productivity growth in the future,” it said.

The OECD expects U.S. investment in AI to continue to grow next year, although at a slower pace.

“AI-related investment has clearly been a major driver of growth this year, and our view is that this is likely to continue,” the OECD said. “At the same time, we think that the pace of growth of AI-related investment will ease somewhat from the very high rates seen over the past year or so.”

While increased levels of investment by businesses to develop and implement AI may boost growth over coming years, the OECD warned that rising government debt could have the opposite effect.

Yields on bonds issued by governments in advanced economies have risen this year as issuance has hit a record high, pushing up borrowing costs for businesses and households.

“Fiscal vulnerabilities may push long-term sovereign yields higher, tightening financial conditions and hampering growth,” Cormann wrote.

The OECD said the U.S. government’s budget deficit is set to steady at 7.5% of gross domestic product in 2026, before rising to 7.7% in 2027 if policies are unchanged. It expects the government’s total debt to rise to 128.4% of GDP in 2027 from 122.6% this year.

“Fiscal policy is on an unsustainable trajectory,” the OECD said. “A significant adjustment will be required over several years.”

Write to Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

12-02-25 0514ET