How AI Investment Is Shaping the Economy

What You Need to Know:

• AI investment tech is boosting demand and supporting a higher neutral interest rate.
• Strong consumer spending is helping keep the U.S. economy resilient.
• Sticky services inflation may limit the Fed’s room to cut rates.
• Rates are likely to stay higher for longer, with some tightening risk.
• Elevated yields could support the U.S. dollar over time.

Why Might Interest Rates Stay Higher for Longer?

The U.S. economy has shown remarkable resilience. We've seen several challenges over the past year including higher energy prices, trade disruptions and immigration-related labour market shifts. In addition to a surge in artificial intelligence (AI) investment, that resilience is reshaping the outlook for interest rates and the broader economy.

A New View of the Neutral Interest Rate

At the heart of the discussion is the concept of the "neutral rate" of interest—the level of interest rates that neither stimulates nor slows economic activity. We believe the U.S. neutral rate now sits between 3.25% and 3.50%, higher than our previous estimate. This suggests that current monetary policy may already be close to neutral rather than restrictive, meaning the Federal Reserve may have less room to cut rates than many investors expect.

Our revision reflects the unprecedented scale of AI-related investment and the ongoing strength of U.S. consumers.

The AI Buildout Is Becoming a Major Economic Driver

The rapid expansion of AI infrastructure is emerging as one of the most important economic forces of the decade. Technology companies are investing hundreds of billions of dollars in data centres, computing capacity and related infrastructure, with spending expected to continue rising sharply over the next several years.

While AI has the potential to improve productivity and reduce costs over the long term, the initial buildout phase is creating significant demand for labour, materials, power and equipment. That surge in demand can place upward pressure on prices and interest rates before productivity benefits are fully realized. As a result, AI investment may contribute to higher interest rates in the near term, even if it ultimately supports a more productive and efficient economy over the long run.

Consumer Spending Remains Surprisingly Strong

Another factor supporting higher interest rates is the continued strength of U.S. consumers. Despite facing higher prices and several economic headwinds, households have largely maintained spending levels. Strong wealth effects and healthy balance sheets have helped consumers absorb shocks that might previously have slowed economic activity more significantly. This sustained demand has helped keep the U.S. economy growing even as other parts of the world experience slower momentum. For policymakers, it also raises questions about whether current interest rates are restrictive enough to bring inflation fully back to target.

Inflation Remains a Concern

While headline inflation has moderated from its post-pandemic highs, services inflation has proven more persistent. Spending on services remains elevated, and underlying inflation measures have not eased as much as expected despite a softer labour market. This standing could indicate that economic demand remains stronger than traditional measures suggest. If employment growth accelerates again or wage pressures increase, the Federal Reserve could face renewed pressure to tighten policy rather than ease it. While additional rate hikes are not the base case, the possibility has become more significant than markets may currently appreciate.

What Higher for Longer Means for Markets

We believe the Federal Reserve is likely to keep interest rates unchanged for an extended period rather than begin a significant easing cycle. For bond markets, that implies government bond yields could remain elevated. A higher neutral rate could also provide longer-term support for the U.S. dollar.