US Economy Slows as Iran War Fuels Inflation

The US economy expanded more slowly than expected in the second quarter, with an inflation surge that began in the early months of the Iran war weighing on activity, a government report showed on Thursday.

The economy grew at an annualised rate of 1.5% over the three months ending in June. That marked a slowdown from 2.1% growth in the previous quarter and came in below economists’ expectations.

Slower Growth after Earlier Momentum

Despite the cooling, the latest reading was stronger than the 0.5% annualised growth recorded in the final three months of 2025.

The report covered a period that followed a historic global oil shock triggered by the conflict in the Middle East. Gas prices and broader inflation pressures rose during the run-up to and during the initial stages of the Iran war.

The national average price for a gallon of gasoline reached as high as $4.56 in May, according to AAA data. The figure then eased somewhat after a preliminary peace agreement was reached last month.

Inflation Above Target, Hiring Still Solid

Annual inflation has risen to 3.5%, putting it more than a percentage point higher than the Federal Reserve’s 2% target. Even with prices elevated, hiring has remained more resilient than many economists feared, despite higher costs for businesses and consumers.

In recent quarters, the pace of economic growth has also been supported by investment in artificial intelligence. JPMorgan Asset Management said a surge in AI spending accounted for roughly two-thirds of gross domestic product growth over the first half of 2025.

The report noted that the boost from AI spending has outpaced the contribution from hundreds of millions of US consumers. It also said several of the country’s largest companies have directed funds into the chips and data centres needed to run AI systems.

Fed keeps Rates, Futures Hint at Possible Hike

The combination of higher inflation and a still-strong labour market has increased the likelihood of an interest-rate rise, futures markets indicated. Economists warned that a rate increase would raise the risk of weaker economic activity over the coming months, as companies could face higher borrowing costs.

The Federal Reserve said on Wednesday afternoon that it would keep interest rates steady, hours before the release of the GDP data. The benchmark policy rate is set at between 3.5% and 3.75%.

That range is down from a recent peak reached in 2023, but borrowing costs remain well above the near-zero level of 0% set at the start of the Covid-19 pandemic. Fed Chair Kevin Warsh, who took charge this summer, has said he intends to bring inflation down.

“Persistently high prices are a burden for the American people,” Warsh told reporters in Washington, D.C., last month. “This committee will deliver price stability.”

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31 July 2026

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