Han Dieperink: Inflation may come down faster than expected in 2026
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
Most economists and policymakers agree: inflation will remain stubbornly high for the time being. Even the Federal Reserve predicts that core inflation will only fall to 2.6% in 2026 and to 2.4% in 2027. But these predictions are likely to prove too pessimistic. There are powerful forces at work that could push inflation down faster than almost anyone expects.
The invisible hand of technology
The main driving force behind the expected disinflation is the development of new technologies, particularly AI. Every major technological breakthrough in history has increased productivity and thus pushed down prices. Think of the steam engine, electrification and the internet. AI is no exception and could even have a stronger disinflationary effect than previous innovations. Firstly, AI increases economic efficiency by enabling companies to automate tasks and streamline processes. This leads to a sharp increase in output per employee. Secondly, AI exerts downward pressure on wages because the demand for labour decreases. Whereas the internet mainly supplemented and reinforced labour, AI replaces it in many cases. This fundamental difference explains why current productivity gains are so different from those during the internet revolution of the 1990s.
Since 2021, corporate profits in America have risen by about 60%, while nominal wages have risen by only 25%. In real terms, corporate profits rose by about 30%. In contrast, the real wages of ordinary workers rose by only 2% over the same period, or about 0.4% per year. Real wages are lagging behind productivity growth, widening the gap between corporate profits and labour income.
These productivity gains translate directly into lower costs per unit of output. When companies can produce more with the same or even less labour input, there is no longer any need to pass on higher costs to consumers. This mechanism is reinforced by international competition and consumers' willingness to switch to cheaper alternatives. In the long run, this inevitably leads to lower consumer prices.
The parallel with the 1980s
The current disinflation process bears striking similarities to the 1980s. In both periods, the inflation shock stemmed from disruptions on the supply side of the economy. In 1980, it was the oil crisis that caused prices to skyrocket. In 2021, the coronavirus pandemic brought global supply chains to a standstill, leading to severe shortages and a sudden jump in price levels. The subsequent disinflationary process is remarkably similar in both cases. Core inflation is falling by roughly 100 basis points, or one percentage point, per year. With current core inflation at around 2.8% on an annual basis, it is entirely realistic that inflation will move towards 2% in the course of 2026. If this historical pattern continues, a further decline of 60 to 80 basis points is very possible.
One of the most underestimated disinflationary forces is the changing dynamics of the labour market. Wage growth is cooling, while employment growth is stagnating. This is partly the result of the adoption of AI and automation, but also of demographic shifts and changing work patterns since the pandemic. Companies have become more cautious about expanding their workforce. Instead, they are investing in technology that increases labour productivity. The result is what some economists see as jobless growth: the economy is growing and profits are rising, but employment is lagging behind. Demand for labour is declining, while production is increasing. The combination of declining wage pressure and rising productivity creates a powerful disinflationary cocktail. This mechanism may persist longer than many currently expect, as long as the adoption of AI technology continues and companies continue to invest in automation.
Two components that played a disproportionately large role in the inflation spike of 2021-2023 are housing costs and energy prices. Both are now undergoing significant normalisation. House prices are stabilising or falling in many markets, while rental growth is slowing. This is important because housing costs have a large weight in inflation figures. Given the delayed effect with which these costs are included in US statistics, this slowdown will only be fully reflected in the official figures for 2026. In other words, the decline that is already taking place in the housing market will only be fully reflected in inflation figures next year. We are also seeing a favourable development in the energy sector. Crude oil prices have fallen and the outlook points to a further moderate development. The energy transition and the increase in renewable energy sources are contributing to a structurally lower cost base for energy in the longer term. These factors combined support the scenario of surprisingly low inflation in 2026.
Import tariffs in perspective
Of course, there are also factors that could slow down disinflation. The threat of increased import tariffs poses a real risk of driving up the prices of goods. However, tariff increases lead to one-off price jumps, not sustained inflation. Once the initial shock has been absorbed, the underlying disinflationary trends resume their work. We saw a similar effect with the VAT increases in Japan during the economically difficult years: temporary price increases followed by a return to the structural trend. Moreover, experience from previous trade conflicts shows that the actual impact on consumer prices is often smaller than feared. Companies absorb part of the cost increase in their margins. Consumers switch to domestic alternatives. And the strength of the dollar dampens the impact of higher import costs. The tariff risk is therefore real but manageable and will not fundamentally disrupt the broader disinflationary trend.
Lower inflation = lower policy interest rate
The implications of faster-than-expected disinflation are significant. For the Federal Reserve, this means there is more room for interest rate cuts than is currently priced into the market. If productivity growth continues and inflation falls faster, the central bank may be forced to cut interest rates more than expected, even as the economy continues to grow and corporate profits increase. This scenario is reminiscent of the second half of the 1990s. At that time, internet-driven productivity growth pushed core inflation below 2%, prompting the Fed to ease policy despite economic growth of nearly 4%. The combination of strong growth and falling interest rates led to a powerful rally in the equity markets.
Investors who are positioning for persistently high inflation run the risk of being on the wrong side of the market. For policymakers, the challenge lies in recognising the changing inflation dynamics in a timely manner. There is a risk that the Fed will stick to a restrictive policy for too long, causing unnecessary economic damage. Past experience teaches us that central banks regularly lag behind the curve, both in combating inflation and in recognising disinflation.
The convergence of technological innovation, changing labour market dynamics, falling housing costs and moderate energy prices is creating a powerful disinflationary environment. The historical pattern of the 1980s suggests that we still have significant scope for further declines in inflation. Although rate risks may cause temporary disruptions, the structural forces driving disinflation remain intact. It is highly likely that both the markets and the Federal Reserve will be surprised by the speed at which inflation declines in 2026.