A troubling forecast for the U.S. economy suggests that the nation could be facing a “stagflation lite” scenario by 2026, according to recent insights from RBC. The bank’s economists have highlighted the potential for the economy to experience below-trend growth combined with persistently high inflation, indicating that core inflation could remain above 3% throughout much of the year. Stagflation, a situation where inflation is high while economic growth slows, poses unique challenges for the Federal Reserve, particularly because it complicates the central bank’s ability to adjust interest rates accordingly.
Several key factors are driving this concerning outlook:
High Housing Costs
Among the most significant pressures contributing to sustained inflation is the high cost of housing. RBC noted that core services inflation, which excludes volatile food and energy prices, has recently registered around 3.5% year-over-year—a sign that inflationary momentum persists. Although home prices have begun to decelerate, they have seen substantial increases over the past five years, with a reported 1.3% rise year-over-year as of September, according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index. The “owners’ equivalent rent,” another measure of housing expenses, increased by 3.7% year-over-year as of September. This measure reflects the hypothetical rent homeowners would pay for their own properties and is anticipated to add upward pressure to the core Consumer Price Index (CPI). RBC does not foresee any relief from this component aiding the Federal Reserve’s target inflation rate of 2%.
Sticky Wage Growth
Wage growth is another critical driver keeping inflation elevated. Average hourly earnings for private-sector employees grew by 3.8% year-over-year as of September, indicating robust wage pressures. RBC emphasized that core services inflation, excluding housing, has not turned negative over the last four decades, predominantly due to wage-driven inflation. The economists predict limited opportunities for disinflation, suggesting that the correlation between wages and core service costs is likely to persist without significant reductions.
Tariff Impacts
Inflation related to goods is projected to remain sticky as well. It has seen a continuous increase over the past year, with an annualized rate of 1.8% reported in September. RBC anticipated that price elevations for goods would follow the normalization of supply chains post-pandemic. However, the introduction of tariffs under the previous administration is expected to keep inflationary pressures high. RBC expressed concerns that the full impact of these tariffs has yet to be felt regarding consumer goods prices and predicted that this pressure could peak in the second quarter of 2026.
Heavy Government Spending
Heavy government spending is also seen as a double-edged sword. While such spending can stimulate the economy, it may simultaneously stifle medium-term growth due to potential reductions in productivity in the public sector. Despite a slight contraction in GDP at the beginning of the year, the economy rebounded with projected year-over-year GDP growth of approximately 3.9% for the third quarter. However, ongoing government debt, projected to reach a staggering $21.1 trillion deficit over the next decade according to the Congressional Budget Office, adds further inflationary pressures that could contribute to the stagflationary scenario.
As the economy approaches this precarious balance, economists and policymakers will need to navigate through these challenges with caution to mitigate the potential repercussions of prolonged inflation coupled with subdued growth.
