Global Economic Outlook — February 2026

Key macro themes shaping markets as 2026 gets underway: a cooling but resilient U.S. cycle, a euro area recovery that is stabilizing just as FX dynamics return to the policy debate, the UK’s slow-growth equilibrium with sticky domestic inflation pressures, Japan’s normalization path complicated by election-driven fiscal risk and JPY volatility, and China’s managed stabilization amid weak consumption and lingering property stress. The report highlights the month’s major “tone-setter” data—PMIs, jobs, inflation, retail demand, credit, and trade—while translating them into practical implications for rates, FX, equities, and commodities. Expect a scenario-based framework that flags the biggest catalysts, policy pivots to watch (Fed/ECB/BoE/BoJ/PBoC), and the geopolitical and trade risks that could tighten financial conditions quickly.

US Economy in February, Current condition and Outlook

The outlook is cautiously optimistic but highly data dependent. The economy looks set to keep expanding, but cooling trends in hiring and demand must be monitored closely. Inflation should ease but unevenly keeping the Fed cautious and pushing the market’s “two cuts later in 2026” narrative to depend heavily on payrolls, CPI/PPI, and PCE. Earnings and fiscal tailwinds may support risk assets, but stretched valuations leave markets vulnerable to negative surprises and headline shocks.

U.S. Economy Review — January 2026

January 2026 began with the U.S. economy carrying strong late-2025 momentum but facing classic late-cycle constraints: sticky inflation dynamics, a cooling labour market, and an unsettled geopolitical/policy backdrop. For most of the month, the data suggested a “cooling but resilient” economy—growth remained solid, services and consumer activity held up, and manufacturing showed early signs of stabilization. The final week became more volatile, with markets reacting more to policy and geopolitical headlines than to underlying macro fundamentals. Overall, the economy entered 2026 on firm footing, but with a clearer shift toward moderation rather than renewed acceleration.

Real-time growth tracking captured that nuance. The Atlanta Fed’s GDPNow estimate for Q4 2025 stepped down from very strong levels 5.4% early in January to 4.2% by January 29—still robust but implying that part of late-2025 strength was driven by trade and inventory swings rather than durable final demand. Hard activity data were supportive: industrial production rose 0.4%/m in December, manufacturing output gained 0.2% m/m, and capacity utilization rose to 76.3%, consistent with factories operating near long-run norms. Regional surveys also improved, though input cost pressures remained elevated.

The month reinforced a two-speed economy. Services stayed comfortably expansionary (ISM Services 54.4), while manufacturing remained in contraction (ISM Manufacturing 47.9), reflecting weaker new orders and employment. The trade picture was also volatile: a sharp narrowing of the goods deficit in October likely supported growth, but the deficit widened again in November, shifting net exports from a tailwind to a headwind.

Consumers appeared steady but interest-rate sensitive. Nominal spending remained positive, yet real income momentum was uneven, and housing stayed constrained by high financing costs. Confidence improved modestly (Michigan sentiment 56.4) and near-term inflation expectations eased to 4.0%, while longer-term expectations ticked higher. Housing activity remained mixed: permits suggested pipeline stability, starts softened, and mortgage applications swung sharply with rate changes.

Financial conditions were heavily influenced by headlines—most notably a brief risk-off episode tied to tariff rhetoric and renewed attention to Fed leadership as President Trump nominated Kevin Warsh to replace Jerome Powell (term ending May 2026). Strong foreign demand for U.S. assets in November TIC data provided a stabilizing counterweight.

The labour market cooled but did not crack: December payrolls were modest (+50k), unemployment edged down to 4.4%, and wage growth stayed firm (3.8% y/y) while claims remained low. Inflation remained contained at CPI (2.7% headline, 2.6% core) but producer prices were hot, complicating the easing outlook. The Fed held at 3.75%, emphasizing caution. Looking ahead, the balance of risks is even: easing later in 2026 is plausible, but only if inflation pressures continue to fade without renewed shocks.

U.S. Economic Outlook for February 2026

February 2026 opens with the U.S. economy still expanding but clearly cooling from the above-trend pace seen into early 2026. The central narrative is late cycle: supportive supply-side dynamics (notably productivity) are helping growth hold up, while inflation returns only gradually toward target and the labour market continues to soften. That mix keeps the Federal Reserve in a cautious, data-dependent stance—more consistent with rate cuts later in 2026 than an imminent pivot—unless a shock materially tightens financial conditions or disrupts demand.

Macro backdrop: “slowing, not stalling”

Baseline expectations point to an economy that avoids recession unless hit by a major downside catalyst (tariffs, geopolitics, shutdown-related uncertainty, or a sudden labour-market deterioration). A key upside risk is a productivity-led expansion, tied to AI adoption, investment, and infrastructure upgrades. This is important because it offers a pathway to maintain decent real growth without reigniting inflation as strongly as in past cycles. The labour market is expected to cool without breaking hiring remains subdued, unemployment may drift modestly higher, and “labour hoarding” gradually unwinds. However, wage growth may remain firm enough to keep services’ inflation sticky, implying inflation could fall unevenly and keep policymakers cautious.

February’s front-loaded data calendar: the “tone-setters”

The month’s macro flow is heavily front-loaded and designed to answer one question: Is the economy cooling smoothly—or re-accelerating enough to delay easing?

• Early-cycle reads (Feb 2–5): ISM manufacturing and construction spending (Feb 2) set the tone for factories and capex; JOLTS openings (Feb 3) clarifies labour demand; ADP and ISM services (Feb 4) provide the first employment/services pulse; trade balance, jobless claims, and productivity/unit labour costs (Feb 5) help triangulate external demand, labour tightness, and labour-cost pressure.
• Key inflection point (Feb 6): The Employment Situation report is expected to show payroll growth rebounding to ~80K (from 50K) with unemployment around 4.4% and earnings up ~0.3% m/m (y/y pace easing toward ~3.6%). Benchmark revisions could also reveal that 2025 hiring was overstated, reinforcing the “slower income support” theme for consumption.
• Inflation focusses (Feb 11–12): CPI and PPI will determine whether disinflation remains intact or if upstream cost pressures keep the Fed cautious.
• Demand and the broader picture (Feb 17–27): Retail sales and inventories (Feb 17) test consumer momentum; the first GDP estimate and PCE/income (Feb 20) reconnect growth to the Fed’s preferred inflation gauge; durable goods (Feb 27) give a clean read on business investment appetite.

Micro drivers: earnings and fiscal tailwinds

February sits in the heart of earnings season, with investors looking beyond headlines to guidance on AI capex, margins, and free cash flow. Mega-cap tech results—especially Apple and Amazon—are central to the market narrative around the “AI super-cycle,” while results across banks (JPMorgan Chase, Bank of America, Wells Fargo) and industrials (Caterpillar) test the breadth of profit resilience.

On fiscal policy, the text highlights stimulus-like support via the One Big Beautiful Bill Act, including tax refunds and investment incentives (bonus depreciation and other provisions). The market implication is near-term support for both household cash flow and corporate investment, which is helpful for growth, but potentially complicating if it slows disinflation.

Market focus: USD, rates, and risk sentiment

For the USD, the dominant drivers rate differentials and data surprises. Strong payrolls or CPI could delay the expected easing path and support the dollar; softer data would do the opposite. Global central bank decisions matter too, especially the early-February meetings of the European Central Bank and Bank of England, which could shift relative policy expectations. The outlook also flags geopolitical risk (including the Feb 4 expiry of the New START Treaty) as a potential safe-haven driver for USD moves.

For Wall Street, February is a stress test of “Goldilocks” pricing: robust growth with moderating inflation. Earnings delivery matters as much as macro, particularly given high valuations and the market’s sensitivity to AI-related guidance. Fed communications are another catalyst, including investor reaction to President Trump’s nomination of Kevin Warsh to replace Jerome Powell (term ending May 2026), which can affect perceptions of the reaction function and institutional independence.

Government shutdown risk: contained, but a volatility catalyst

A brief partial shutdown began after funding deadlines were missed, even though the United States Senate later passed a stopgap package while the United States House of Representatives was away. The structure isolates a dispute over Department of Homeland Security funding and immigration enforcement rules, following public outrage tied to the death of Alex Pretti. Historically, short funding gaps often have limited economic impact, but they can still raise uncertainty premium and amplify market moves.

UK Economy — January 2026 Takeaways and February 2026 Outlook

February should reinforce a slow-growth, disinflation-in-progress picture. A BoE hold looks likely, but the meeting is pivotal because it can shift the market from “later in 2026” to “as soon as March,” depending on inflation and wage signals.

January Review

The UK enters February with a balanced but cautious outlook. Growth remains modest and uneven, inflation is improving but not fully contained, and the labour market is cooling gradually. The most likely scenario is continued low-speed expansion, with the Bank of England staying firmly data-dependent and leaning toward potential rate cuts later in 2026, but only if there is clearer evidence that services inflation and wage growth are cooling sustainably.

January data reinforced the theme of a slow-growth equilibrium. Business surveys were marginally positive: the Composite and Services PMIs hovered around 51.4, signaling weak but ongoing expansion led by services. Manufacturing was only slightly above the 50 line (around 50.6), consistent with stabilization rather than a meaningful rebound. The major drag remained construction, where PMI readings near 40 points to deep contraction and ongoing strain in building activity and housing-related supply chains. Overall, growth exists but is narrow and therefore more exposed to shocks.

Housing conditions softened again. Major house price measures fell month-on-month, and annual gains remained very low, highlighting how elevated borrowing costs continue to cap demand. Even so, households have not fully retreated: mortgage approvals were near expectations and net lending to individuals stayed surprisingly firm despite mortgage rates around 6.8%. However, negative housing equity withdrawal indicates homeowners are not drawing on housing wealth to fund consumption, limiting the scope for consumer-led acceleration.

Inflation trends are improving, but the job is not done. Retail goods inflation looked contained early in the month, helping real incomes, but later shop-price readings reminded markets that food and energy can reintroduce pressure. More importantly for policy, underlying inflation, especially wage- and services-driven components—remains sticky, complicating the policy outlook.

Financial conditions eased slightly at the margin as money and credit indicators improved and gilt yields drifted lower (mid-maturities around 4%), consistent with expectations that the restrictive phase is nearing its peak. In the real economy, there were resilient pockets—some upside surprises in output and modestly improved retail volumes—but a wider trade deficit and ongoing construction weakness show the recovery is still not broad-based. The labour market cooled without breaking: unemployment held near 5.1% and wage growth moderated to the mid-4% range, reflecting “no hire, no fire” dynamics that support stability but imply softer income momentum ahead.

February 2026 UK Economic Outlook

February 2026 is likely to keep the UK in slow growth, late-cycle equilibrium: activity expands modestly, inflation lower but remains above target, and the labour market loosens gradually. High-frequency indicators and consensus forecasts suggest subdued GDP growth (around 1.4% annualized), with services and manufacturing contributing only modestly while construction and housing remain persistent drags. The policy debate is therefore less about whether easing is coming and more about timing—with markets leaning toward a first rate cut in March or May, rather than February.

Core macro picture: modest growth, sticky domestic inflation

The UK’s growth mix remains narrow. Services continue to do most of the lifting, manufacturing is stabilizing, and construction/housing are lagging. Inflation is moving in the right direction, but not quickly enough to remove policy caution. Energy costs have softened, helping the headline outlook, yet wage-driven services inflation remains sticky—one of the key reasons the Bank of England is unlikely to rush into near-term cuts.

The main February catalyst: the Bank of England meeting (5 February)

The defining market event is the Bank of England’s February meeting. A hold at 3.75% is the dominant expectation, but what matters for pricing is the tone: the voting split, the Monetary Policy Report (MPR), and how explicitly the Committee signals an easing path.

A plausible base case is a close vote (5–4) that still favors holding rates, while communicating an easing bias. If the MPR pushes inflation forecasts closer to target in 2026—reflecting moderating earnings growth and fiscal/price dynamics—markets may interpret this as laying the groundwork for a March cut. In that scenario, gilt yields would likely drift lower, and sterling would face downside pressure. Conversely, if the BoE emphasizes persistent domestically generated inflation risks (services and wages) or delivers a more hawkish vote/tone, it could support GBP and keep front-end yields elevated.

External forecasts add nuance. Some strategists see limited room for deep easing, warning that structural constraints—high public debt, high taxation, and heavy gilt issuance—may keep longer-term yields relatively high even if Bank Rate eventually falls. That implies financial conditions may ease only gradually, not dramatically.

A Reuters poll (late January) underscores the market balance: most economists expect a hold in February, with a slim majority anticipating a cut to 3.5% in March, reflecting improving inflation trends but still-elevated UK price pressures compared with peers and a narrowly split MPC.

Inflation and labour: the gating factors for rate cuts

Inflation remains the critical constraint. Recent official data showed headline CPI at 3.4% y/y and core at 3.2% (December). February’s CPI release (January prices) is the next major checkpoint. High-frequency pricing suggests retail prices rose early in the year, but the easing in energy costs could pull the broader trend down. If inflation falls faster than expected, especially if core services inflation cools—rate cut expectations could firm up quickly.

The labour market is loosening but not collapsing. Unemployment has risen to about 5.1%, and PAYE employment has declined over the past year, with job losses concentrated in cyclical consumer-facing sectors such as hospitality and retail. At the same time, household resilience has improved as inflation has eased and nominal wages remained strong. Business survey evidence also points to reduced labour tightness: only a minority of firms report worker shortages (near the lowest since 2021), which should help wage growth decelerate further. However, labour costs remain a leading concern for many firms, suggesting wage pressures have not fully dissipated—another reason the BoE will want clearer confirmation before easing.

Demand, housing, and global risk

Retail sales volumes rebounded in December, but February will help determine whether that was a one-off holiday effect or the beginning of sustained improvement. Housing remains a key vulnerability: weak prices, elevated mortgage rates, and sensitivity in approvals and lending can quickly feed into broader confidence and consumption.

Global factors matter as well. The UK is highly exposed to shifts in global risk sentiment, currency moves, and trade dynamics—highlighted by how quickly tariff headlines and USD swings can tighten financial conditions and affect imported inflation.

February calendar: the key checkpoints

• 5 Feb: BoE decision and Monetary Policy Report; plus, updated ONS business/real-time indicators.
• 13 Feb: Monthly GDP and industrial production—confirmation (or not) of momentum into year-end.
• 15 Feb: Labour market data (pay growth, payrolls, vacancies)—tests the “cooling” narrative.
• 20 Feb: CPI (January) the key release for the timing of cuts, especially services inflation.
• Late Feb: Retail sales and consumer confidence—signals for Q1 demand durability.

Eurozone Economic Condition and February Outlook

The euro area starts February from a position of relative strength—better Q4 growth, improved sentiment, stabilizing industry—but remains constrained by sticky core inflation, weak exports, and national divergence. The ECB is likely to stay patient, with FX now back on the radar: continued euro appreciation would increase the odds of earlier easing, potentially as soon as March.

Eurozone Economic Review – January 2026

The euro area enters February 2026 in a slow but resilient expansion, led by services and supported by improving credit transmission and a still-firm labour market. Industrial activity is showing early signs of stabilization and retail demand has improved, but the recovery remains constrained by country divergence and lingering external demand weakness. Inflation is close to the European Central Bank’s 2% objective on the headline, yet core inflation remains sticky, leaving policymakers cautious as they balance supporting growth against the risk of re-embedding underlying price pressures.

January survey data painted a mixed picture. The December Composite PMI was 51.5, driven by services (52.4) while manufacturing stayed in contraction (48.8). Construction also remained weak (47.4), reinforcing that higher rates continue to weigh on interest-sensitive sectors. National trends underlined the bloc’s divergence: Germany showed pockets of industrial improvement but struggled with export softness; France was weaker on consumption and remained the low-inflation outlier; Italy and Spain maintained stronger internal momentum.

Inflation progress is real but incomplete. Headline CPI stood at 2.0% y/y in December and core CPI at 2.3% y/y, with modest monthly increases. Producer prices were still down year-on-year (around –1.7% y/y in November), but a positive monthly gain (about +0.5% m/m) hinted that upstream disinflation is no longer a straight-line story. Survey-based inflation expectations also firmed, suggesting the last mile back to fully “settled” inflation may be uneven.

Demand and labour conditions offered support. Retail sales rose 0.2% m/m and 2.3% y/y in November, exceeding expectations and indicating households continued to spend despite restrictive borrowing costs. However, sentiment remained fragile: the Business and Consumer Survey eased to 96.7, and consumer confidence stayed deeply negative (around –13.1), consistent with a cautious consumer still sensitive to energy prices and geopolitical risk. The labour market continued to improve on the margin, with unemployment at 6.3% in November. Meanwhile, financial and credit conditions kept normalizing: broad money growth (M3) accelerated to roughly 3.0% y/y, and lending to non-financial corporates grew around 3.1% y/y.

Markets viewed January as stabilization with episodic headline risk. Mid-month, sentiment improved and industrial production strengthened, but the trade surplus narrowed, highlighting external constraints. Late in the month, flash PMIs suggested softer services momentum alongside modest manufacturing improvement, while EUR/USD remained vulnerable to trade and geopolitical headlines.

February 2026 Euro Area Economic Outlook

Looking into February, the growth backdrop is slightly better than expected. Eurostat’s flash estimate showed Q4 2025 GDP at 0.3% q/q and 1.3% y/y, led by Spain, with Germany and Italy also expanding. Combined with stronger sentiment indicators, the euro area begins February with improving momentum—yet still constrained by weak exports, uneven country performance, and sticky core inflation.

February 2026 is shaping up as a confirmation month for the euro area: markets want evidence that Q4’s resilience can carry into early 2026 without re-igniting inflation persistence. The baseline outlook is constructive but cautious—a slow but steady expansion led by services, supported by stabilizing industry and improving credit transmission. With inflation near target and unemployment close to record lows, the European Central Bank is expected to remain patient and data-dependent, keeping policy steady unless inflation falls faster than expected or growth weakens materially.

Macro backdrop: modest growth, contained inflation, tight labour markets

Q4 GDP confirmed that the recovery is being driven primarily by domestic demand—consumption and investment—rather than exports. Sentiment indicators improved meaningfully in January, suggesting momentum was carried into the start of 2026. Growth is expected to remain around potential—roughly 1.2%–1.5% annualized—with Spain and Italy continuing to outperform the bloc average. Germany remains the swing factor, but incremental industrial stabilization and the prospect of fiscal expansion (infrastructure/defense) later in 2026 could provide a stronger tailwind over time.

Inflation is broadly anchored near 2%, and the easing trend in wages and core services inflation is encouraging, but underlying pressures remain above pre-pandemic norms. That keeps the ECB cautious: policymakers need clearer evidence that core inflation will cool sustainably before leaning decisively toward easing. The labour market remains supportive, with unemployment around 6.2% and scope for further marginal improvement, although some gradual loosening is expected.

The ECB in February: steady decision, higher FX sensitivity

The key event is the ECB Governing Council meeting (4–5 February). No rate changes are expected. Instead, attention will focus on President Christine Lagarde’s press conference and updated projections. A meaningful shift toward an easing bias would likely weigh on the euro; a firm “hold” message would support it. Market consensus is broadly for rates to stay unchanged through mid-2026 unless inflation undershoots or growth disappoints.

What makes this meeting more consequential is the euro’s recent strength, driven largely by a weaker U.S. dollar. ECB officials have framed FX not as a target but as a transmission channel: euro appreciation reduces imported inflation and can tighten financial conditions and weaken export competitiveness. Policymakers such as Martin Kocher, François Villeroy de Galhau, and **Luis de Guindos have signalled that persistent appreciation matters insofar as it lowers inflation. The note suggests the recent move—about 3.5% versus the dollar and 1.5% in effective terms since December—could mechanically shave roughly 0.1pp from inflation projections. If appreciation continues, the probability of a March rate cut would rise, particularly if the forecast path begins to show inflation drifting below 2% for an extended period.

Key market drivers and risks in February

1. Inflation: Eurostat’s flash HICP (January) on 4 February is central, especially with methodological changes taking effect. A downside surprise would strengthen dovish expectations; a re-acceleration in core services would delay them.
2. Confidence and PMIs: Final January PMIs and February flash PMIs (20 Feb) will test whether January’s improvement is durable.
3. Growth confirmation: The second estimate of Q4 GDP (9 Feb) will reveal how much came from consumption, investment, and net exports—important for durability.
4. Industry and trade: Industrial production (13 Feb) and trade balance (15 Feb) will show whether industrial stabilisation is real and whether external weakness is worsening.
5. External shocks: U.S. trade policy headlines, China competitive pressures, energy price volatility (especially gas), and geopolitics (Middle East/Eastern Europe) remain key sources of risk-premium shifts.

EUR and market implications

EUR/USD is likely to trade primarily on the ECB–Fed policy gap and global risk sentiment. With both central banks expected to stay on hold in the near term, the pair may remain range-bound but sensitive to data surprises. A stronger euro could become a headwind for exports and industry—raising ECB discomfort—while renewed trade tensions or a stronger dollar would weigh on the euro, supporting exporters but complicating imported-inflation dynamics.

China Economic Review – January 2026 and February 2026 Outlook

China Economic Review

China started 2026 in a managed stabilization phase, with policymakers prioritizing targeted support and financial stability rather than broad-based stimulus. Early January data showed services still expanding—the December Caixin services PMI held at 52.0—while inflation stayed subdued, giving Beijing room to support activity without risking renewed currency pressure. December CPI rose 0.8% y/y (0.2% m/m), and producer-price deflation eased to –1.9% y/y, reinforcing a “two-speed” price environment: consumer prices are firming modestly, while upstream deflation is fading but not gone. Policy support leaned toward targeted household subsidies (about 62.5bn CNY) rather than headline fiscal bazookas.

The People’s Bank of China emphasized FX stability, setting a stronger daily midpoint and overseeing an increase in foreign-exchange reserves to $3.358trn. External policy and technology tensions remained a source of uncertainty, with export-control actions and scrutiny of AI-related transactions underscoring that geopolitics and industrial policy can still disrupt trade, investment, and supply chains.

Week two brought more constructive signals. Credit growth surprised to the upside, with December new bank lending jumping to 910bn CNY, M2 growth accelerating to 8.5% y/y, and total social financing staying robust at 2.21trn CNY (down from November but still solid). Trade also beat expectations: the surplus remained very large (around $114bn), exports rose 6.6% y/y, and imports gained 5.7% y/suggesting resilient external demand and some improvement in domestic demand. At the same time, new guidance around advanced AI chip procurement reinforced Beijing’s push to channel investment toward domestic technology supply chains.

Later in January, the broader macro picture remained uneven. Q4 GDP grew 4.5% y/y, holding full-year growth at 5.0%, but the composition was imbalanced: industrial production (about 5.2% y/y) continued to outperform retail sales (0.9% y/y), highlighting the ongoing weakness in consumption. Fixed-asset investment contracted 3.8% in 2025, reflecting the property slump and cautious private investment, while unemployment hovered near 5.1%. The PBOC kept benchmark lending rates unchanged (1-year LPR 3.0%, 5-year 3.5%), signaling a preference for targeted tools over broad rate cuts. The National Development and Reform Commission outlined a 2026–2030 framework aimed at lifting consumption, particularly in services.

The yuan strengthened after a notably firm fixing, briefly breaking below 7 CNY/USD, but persistent confidence issues remained visible through equity outflows and weaker FDI (–9.5% y/y in 2025). The property sector continues to be a structural drag. Adding to the caution, official January PMIs released at month-end slipped into contraction (manufacturing 49.3, non-manufacturing 49.4), even as industrial profits rose 0.6% in 2025, the first annual increase since 2018, aided by measures to curb destructive price wars.

China: February 2026 Outlook

February 2026 will be a stress test for China’s “managed stabilization” story. The economy heads into the Lunar New Year period with soft domestic demand, factory activity hovering around stall speed, and a policy stance that remains supportive but incremental. Markets will focus on whether China can sustain momentum without a broader stimulus package—and whether exports can continue to carry growth as trade frictions, tariff risks, and base effects complicate the external outlook.

Macro indicators point to subdued momentum. Expectations for January PMIs cluster around the 50 lines: the official manufacturing PMI is seen as nearly 50.0 (slightly down from 50.1), while the Caixin/RatingDog manufacturing PMI is expected to be around 50.3. This implies manufacturing is closer to stagnation than expansion. Interpretation is complicated by Lunar New Year timing: factories may front-load production ahead of holiday closures, temporarily lifting output and shipments, then soften as travel ramps up and operations slow. Services should remain modestly expanding, but the tone is cautious, with signs that labour conditions are softening and firms are adjusting staffing and inventories. The near-term message is stabilization without clear acceleration.

On policy, the consensus view remains that 2026 growth moderates to around 4.5%, with consumer inflation still subdued near 0.7%. That backdrop keeps the People’s Bank of China biased toward easing, but in a measured way: markets expect ample liquidity around the holiday via reverse repos and other tools, with the possibility of a small policy rate cut (~10bp) in Q1. After the holiday, investors will watch for an RRR cut or a reduction in the one-year LPR if deflationary pressures persist and domestic demand fails to improve. Fiscal and quasi-fiscal support remains targeted rather than sweeping, exemplified by front-loaded ultra-long special bond funds (62.5bn yuan) used to subsidize household upgrades (appliances, smartphones). The implication is clear: policy is fine-tuning demand and confidence without re-opening a leverage-heavy stimulus cycle—at least until after March’s major policy meetings.

The external sector is still a stabilizer but faces higher uncertainty. Late-2025 trade strength showed that exports can support growth, and policymakers will likely respond with more stimulus if exports weaken materially in 2026. However, February trade data will be noisy. Shipments were likely pulled forward ahead of tariff risk, creating base effects that can make early-2026 momentum look weaker than it is. Consensus expectations point to exports growing around 3.9% y/y and imports around 1.4% y/y, with non-developed markets providing resilience. Lunar New Year also suppresses port and factory activity, and logistics disruptions (including blank sailings) can distort the prints. As a result, investors will focus less on headlines and more on direction: is export resilience fading or holding?

Consumption remains the weak link. Confidence is still constrained by the property downturn and softer income expectations, and Beijing is committed to lifting consumption’s role over time. Near-term inflation should stay low: CPI is likely below 1%, PPI still in mild deflation. Holiday-related services inflation (travel, dining) may spike seasonally, but the market will treat February inflation primarily as a gauge of whether deflationary pressures are easing at the margin.

On micro drivers, the post-holiday earnings season will matter more for equities, especially in high-beta sectors that benefited from a firmer yuan and liquidity support. Investors will look for strength in new energy vehicles, high-end manufacturing, and internet services to offset weakness in traditional sectors. Property remains the core domestic drag, with ongoing price declines, unfinished projects, and potential credit stress—especially among smaller banks with real-estate exposure. The yuan’s recent strength is likely managed with a two-way bias: gradual appreciation is tolerated, but excessive gains may be resisted to avoid tightening conditions. Persistent equity outflows and weaker FDI trends underscore incomplete confidence repair.

February watchlist: Caixin manufacturing (2 Feb), Caixin services (4 Feb), FX reserves (7 Feb), trade and CPI/PPI (8–9 Feb), holiday high-frequency consumption indicators (mid-Feb), and late-month credit/TSF. Overall, February looks cautiously downbeat: stabilization should hold, but acceleration is unlikely without stronger domestic demand or a clearer policy pivot.

Japan Economy Review — January 2026 and February 2026 Outlook

February should be viewed as a policy-validation month. Growth likely continues at a moderate pace, but volatility in rates and FX may persist until election-driven fiscal uncertainty clears. Watch the election outcome and funding plans, underlying inflation metrics, Shuntō wage signals, and trade/production data for confirmation on whether Japan’s normalization can proceed without destabilizing markets.

January 2026 review

January 2026 reinforced Japan’s familiar macro pattern: the economy is moving from reflation toward policy and cycle normalization, but progress is uneven and increasingly shaped by political and market sensitivity. Activity indicators improved from late-2025 softness and external balances remained supportive, yet parts of domestic demand and investment momentum weakened. Inflation cooled on headline measures late in the month, but underlying pressures stayed above the Bank of Japan’s 2% target, leaving the door open to further tightening—subject to growth and financial-stability constraints. February’s outlook will hinge on how markets digest the political backdrop and whether post-holiday activity aligns with the BoJ’s “moderate growth” narrative.

Early January suggested stabilization but with a softer income pulse. The au Jibun Bank manufacturing PMI returned to the 50 thresholds, implying factory activity was no longer contracting. Services eased to 51.6, leaving the composite at 51.1, still expansionary, but consistent with moderation rather than re-acceleration. Households surprised positively on spending (November up 2.9% y/y and 6.2% m/m), but income momentum weakened: wage income rose only 0.5% y/y, overtime pay slowed to 1.2%, and confidence remained depressed (37.2). That combination implies consumption can hold up in the short run but remains fragile without stronger income growth.

Markets were dominated by monetary policy and the repricing of rates. Governor Kazuo Ueda reiterated that the BoJ will raise rates if conditions allow. After the December move, the policy rate sat at 0.75%, the highest in decades, and balance-sheet normalization became clearer with the monetary base contracting 9.8% y/y. Bond yields rose sharply: a 10-year JGB auction cleared at 2.095% and the benchmark yield briefly touched about 2.125%, multi-decade highs. The yen traded largely on rate differentials—USD/JPY moved above 157 before easing toward 156—while foreign flows tilted toward equities and away from bonds, consistent with higher domestic yields.

Mid-month, Japan’s external and credit anchors remained firm, even as sentiment was cautious. The current account surplus widened to ¥3.674tn (adjusted ¥3.14tn), reinforcing strong net external income. Bank lending grew 4.4% y/y and money aggregates continued to expand. Business indicators were mixed: the Reuters Tankan slipped (to 7 from 10), the Economy Watchers index softened, and machine tool orders still grew 10.6% y/y but cooled. Markets became more headline-driven, with speculation about a snap election and fiscal stimulus lifting equities to new highs, while the yen showed heightened sensitivity—especially versus European currencies—amid shifting expectations for BoJ tightening.

The third week brought clearer domestic softness and a rising fiscal risk premium. Core machinery orders fell 11% m/m and 6.4% y/y, signaling caution on capex. Industrial production dropped 2.7% m/m, the tertiary activity index fell 2.4%, and capacity utilization declined 5.3%, pointing to broad-based cooling. External data showed up better: December trade posted a ¥105.7bn surplus with exports up 5.1% y/y and imports up 5.3% y/y, helped by yen weakness and AI-related demand. Inflation eased (headline 2.1% y/y, core 2.4% y/y), but household inflation expectations stayed elevated.

Political shock then drove markets: Prime Minister Sanae Takaichi dissolved parliament and called an 8 February election, campaigning on expansionary measures including a two-year suspension of the 8% food tax. Investors treated this as a negative fiscal-risk: long-end yields surged (10-year near 2.3%, 30/40-year record highs), and the yen weakened toward ¥158.8 per dollar, implying yields were compensating for fiscal risk rather than signaling stronger real growth.

Late January, headline inflation cooled further—Tokyo core CPI slowed to 2.0% y/y—but underlying inflation remained around 2.4% y/y, suggesting disinflation was partly temporary. Retail sales weakened (–0.9% y/y), while labour stayed tight (unemployment 2.6%, jobs-to-applicants 1.19). Overall, Japan enters February with stable external fundamentals but heightened sensitivity to politics, bond-market dynamics, and the sustainability of domestic demand.

Japan in February

Japan enters February 2026 with a steady but fragile expansion and an unusually high concentration of policy- and market-driven risks. The macro backdrop is not recessionary: the Bank of Japan continues to project moderate growth, the labour market remains tight, and the current account and external balances provide an important stabiliser. The new vulnerability exposed in January is that Japan’s “normalisation” story now hinges not only on inflation and wages, but also on fiscal credibility and the stability of the JGB market. February is therefore less about macro turning points and more about whether policy uncertainty can be contained long enough for the BoJ to stay on a cautious tightening path later in 2026.

1) The pivotal event: the 8 February election and fiscal credibility

The snap general election on 8 February is the dominant catalyst. Markets will care less about the headline result and more about the policy package that follows—especially any commitments on consumption tax cuts and broader fiscal expansion. If the outcome increases perceived odds of unfunded stimulus or a structurally higher deficit path, investors will likely demand a higher term premium on JGBs, pushing long-end yields up and raising volatility. Crucially, yen weakness could follow if higher yields are interpreted as a fiscal-risk premium rather than an improvement in growth prospects.

Conversely, if post-election messaging signals restraint—either through scaled-back pledges or credible financing—the bond market could stabilize, easing pressure on financial conditions and reducing the probability of disorderly FX moves. This interaction matters because even if inflation and wages justify gradual tightening, JGB market stress could force the BoJ to prioritize market functioning and financial stability over further hikes.

2) Inflation and consumption: headline easing, underlying trend matters more

The next macro focal point is national January CPI (mid-month). Base effects and subsidies are expected to keep headline inflation below 2% through March, but markets will concentrate on the underlying measures, especially those excluding fresh food and energy—to judge whether inflation is sustainably consistent with the BoJ’s target.

Consumption is the other key test. Household spending (December) and consumer confidence (January) will show whether the recent rebound is durable or fading. The binding constraint remains income growth: consumption can hold up temporarily, but persistence depends on real wage gains. That puts February’s early signals from the spring Shuntō wage negotiations at the centre of the macro narrative, because stronger wage outcomes underpin durable, demand-driven inflation and reinforce the BoJ’s normalisation path.

3) Activity indicators: noisy near term, clearer after seasonal effects

Short-term activity prints will likely be volatile, reflecting holiday distortions and payback dynamics in production. Investors should look for confirmation across multiple indicators rather than overreact to one release. Key reads include:

• January PMIs: services likely to remain expansionary; manufacturing around the 50 line—stabilisation, not acceleration.
• Core machinery orders and industrial production: critical after January softness in investment signals; prolonged weakness would point to a more cautious capex cycle.
• Business sentiment surveys (Reuters Tankan, Economy Watchers): whether confidence improves after the election.

Externally, January trade data will matter for whether AI-related exports can continue to offset weaker shipments to slower end-markets. External demand remains a stabiliser, but it is also exposed to global growth and policy surprises.

4) Micro drivers: earnings season and wages as the “second inflation test”

February is earnings-heavy (fiscal Q3 reporting). Investors will focus on exporters and tech-sensitive sectors (chip equipment, autos, electronics) for two signals: whether AI demand is supporting profits, and whether yen strength—if it persists—compresses margins or is offset by pricing and hedging. Wage negotiations are the key micro-to-macro bridge: management commentary and early Shuntō signals can move markets by shifting expectations for the BoJ’s next step.

5) JPY drivers: rate expectations, intervention risk, and flows

The base case is BoJ on hold in February but hawkishly biased, with many expecting the next hike around June 2026 once spring wages are clearer. FX dynamics will also depend on the U.S. rate path: if the Fed moves toward cuts while Japan retains a tightening bias, the yen can strengthen over time, though likely with volatility.

Intervention risk remains live. If USD/JPY nears 160, the probability of action rises, particularly around the election window. Positioning matters too: a net-short yen stance among leveraged players could amplify a strengthening move via short covering. Finally, foreign flows will be watched—equity inflows can support the yen (especially if hedged), while bond outflows can deepen rate-driven volatility.