Higher tariffs and immigration restrictions ’a recipe for mild stagflation’: BofA

Bank of America warns of a "mild stagflation" risk for the U.S., forecasting 1.7% growth in 2025-26 alongside core PCE inflation peaking at 3.3% this year and remaining above 3% into 1H26, driven by potential policy shifts like tariffs and immigration restrictions. BofA cautions that a dovish Fed pivot and premature rate cuts could lead to a policy error given supply-side labor market constraints. While global growth is projected to remain steady at 3.1% in 2025, regional outlooks vary, with Europe facing persistent inflation undershoot and China exhibiting persistent domestic demand weakness despite strong H1 2025 growth.

Analysis

Bank of America has issued a cautious U.S. economic outlook, warning of a potential "mild stagflation" scenario driven by policy shifts such as higher tariffs and immigration restrictions. The bank projects U.S. growth will moderate to 1.7% in 2025-26, while core PCE inflation is forecast to peak at 3.3% this year and remain stubbornly above 3% through the first half of 2026. This outlook challenges the narrative of a soft landing, suggesting that premature interest rate cuts by the Federal Reserve could constitute a "policy error," especially as labor market softness is attributed to supply-side constraints. Globally, the forecast remains uneven despite steady projected growth of 3.1% in 2025. The euro area is expected to experience near-zero growth this year and a "persistent inflation undershoot," prompting the European Central Bank to deliver 50 basis points in cuts by March 2026. Conversely, China's strong 5.3% growth in the first half of 2025 is overshadowed by "persistent weakness in domestic demand," signaling a slowdown to 4.1% by 2027.

Key Decisions for Investors

• Given the risk of U.S. stagflation and sticky inflation, investors should reconsider overweight positions in rate-sensitive growth sectors and evaluate assets that offer inflation protection.
• The divergence in monetary policy, with the Fed potentially on hold while the ECB is expected to cut rates, may create opportunities in currency markets, particularly favoring the U.S. dollar against the euro.
• Investors should exercise caution regarding China-exposed assets, particularly those reliant on domestic consumption and investment, due to the flagged 'persistent weakness in domestic demand' despite strong headline growth figures.
• Monitor U.S. trade and immigration policy developments closely, as BofA identifies these as key catalysts for its stagflationary forecast and a primary source of market uncertainty.