Investment and economic outlook, January 2026

The latest forecasts for investment returns and region-by-region economic outlook

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Australia

A modest easing path amid prolonged disinflation

“Labour market tightness and subdued productivity growth will keep upward pressure on unit labour costs, prolonging the disinflation process.” Grant Feng, Vanguard Senior Economist

We expect Australia’s economic growth to hover around trend in 2026, supported by relatively solid incomes, a gradual recovery in private demand, and robust public spending. An improving global growth backdrop will also be supportive. However, an extended disinflation process is likely to result in only a modest Reserve Bank of Australia (RBA) rate-cut trajectory, limiting economic momentum after monetary policy easing last year. 

Labour market conditions remain tight, although there are signs of softening. Australia’s challenge lies in its constrained supply side and weak productivity growth, which have lowered the economy’s potential growth rate. We expect labour market tightness and subdued productivity growth to keep upward pressure on unit labour costs.

With the economy operating near its full capacity and amid evidence that disinflation is stalling, we expect the RBA to emphasise its price stability mandate. We anticipate only one quarter-point cut in 2026, to 3.35%, with that occurring only late in the year. The RBA made three quarter-point cuts in 2025.

Australia economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Trimmed mean inflation is the year-over-year change in the Consumer Price Index, excluding items at the extremes, as of the fourth-quarter 2026 reading. Monetary policy is the Reserve Bank of Australia’s year-end cash rate target.} 

^{Source: Vanguard.} 

Vanguard Capital Markets Model® forecasts

Our 10-year annualised nominal return and volatility forecasts are based on the 31 December 2025 running of the Vanguard Capital Markets Model®.

Australia (Australian dollar)

^{IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modelled asset class. Simulations as of 31 December, 2025. Results from the model may vary with each use and over time. For more information, please see the Notes section below.}

^{Notes: These return assumptions depend on current market conditions and, as such, may change over time. We make our updated forecasts available at least quarterly.}

^{Source: Vanguard.}

United States

Capital spending anchors our growth outlook

“We expect strong capital investment to remain a principal strength in the year ahead, supporting GDP growth above 2% in 2026.” Josh Hirt, Vanguard Senior U.S. Economist

Strong capital investment has been a key driver of U.S. growth over the past year, and we expect it to remain a principal strength in the year ahead, supporting GDP growth above 2% in 2026. A major contributor is the surge in artificial intelligence-related expenditures, which we estimate will fuel nonresidential investment growth of about 7%.

Tariffs and trade policy effects have been muted by import frontloading, exemptions, and delayed price transmission. The pass-through of tariffs to prices will weigh moderately on growth and slow the pace of disinflation early in the year. We see core inflation peaking at just over 3% before moderating as the year progresses.

Labour markets have cooled sharply, with job creation slowing from over 200,000 positions per month at the end of 2024 to around 50,000 currently. But we estimate that demographic and immigration trends account for 70% of the slowdown, and we see underlying conditions remaining resilient. We expect the unemployment rate to settle around 4.2% by the end of 2026.

In a stronger growth environment and with monetary policy now in the range of neutral-rate estimates, we anticipate the Fed will proceed with greater caution and cut rates only once in 2026, early in the year. (The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.)

United States economic forecasts

^{Notes: GDP growth is defined as the fourth-quarter-over-fourth-quarter change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year percentage change in the Personal Consumption Expenditures price index, excluding volatile food and energy prices, as of December 2026. Monetary policy is the upper end of the Federal Reserve’s target range for the federal funds rate at year-end.}

^{Source: Vanguard.} 

Canada

Canada’s economy is positioned for progress in 2026

“Canada’s structural trade advantage and resilient consumer base set the stage for steady growth in 2026.” Adam Schickling, Vanguard Senior Economist

Canada enters 2026 on firmer ground than expected, supported by a resilient consumer and an effective tariff rate among the lowest for U.S. trading partners. After a turbulent 2025 marked by tariff shocks and uneven labour dynamics, Canada’s fundamentals are stabilising. Consumer spending continues to anchor growth, aided by real wage gains and limited job losses. While unemployment rose earlier in 2025 amid weak hiring for new entrants, late-year momentum signaled resilience. 

Fiscal policy will provide a modest tailwind this year through infrastructure and sectoral support, while our expectation of a strong U.S. economy offers an external boost. These dynamics suggest real GDP growth of roughly 1.6% in 2026, and we expect unemployment to trend lower as slower population growth supports higher job-finding rates among younger workers.

In 2025, core inflation measures eased, signaling moderating underlying price pressures and enabling the Bank of Canada to cut rates by one percentage point. However, with core inflation still above target, stabilisation in the labour market, and policy rates aligned with our estimate of neutral, we see little scope for further cuts, or hikes, in 2026. (The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.)

Risks remain around United States-Mexico-Canada Agreement negotiations and commodity price volatility, but Canada’s competitive positioning and pragmatic policy mix suggest continued resilience as global conditions stabilise.

Canada economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2026. Monetary policy is the Bank of Canada’s year-end target for the overnight rate.} 

^{Source: Vanguard.}

Mexico

Entering the new year with cautious optimism

“Despite cyclical headwinds, Mexico’s competitive position in North America remains a powerful anchor for growth.” Adam Schickling, Vanguard Senior Economist

Mexico enters 2026 balancing cyclical challenges with longer-term economic tailwinds. After a sluggish year marked by tariff uncertainty and fiscal consolidation, GDP is expected to rebound in 2026, supported by strong demand from the U.S. Roughly 80% of exports to the U.S. remain duty-free under United States-Mexico-Canada Agreement (USMCA) provisions, placing Mexico’s effective tariff rate among the lowest globally.

Slowing real wage growth and softer remittance inflows from the U.S. will partially offset consumption tailwinds from a resilient labour market, tourism related to soccer’s World Cup, and a sizeable minimum wage increase affecting millions of workers. Longer-term prospects remain constructive. Nearshoring trends continue to strengthen Mexico’s role as a North American manufacturing hub, supported by competitive labour costs, geographic proximity, and deep integration with U.S. industry under the USMCA.

On the policy front, gradual easing by the Bank of Mexico (Banxico) should bring the policy rate toward 6.5% by year-end, supporting credit-sensitive sectors and household consumption. However, lingering cost pressures and sticky core inflation will limit the scope for aggressive cuts. Banxico cut its policy overnight interbank rate to 7% in December.

With the U.S.-Mexico policy rate gap expected to remain relatively stable and the peso’s growing role in global carry-trade dynamics, we anticipate the peso ending 2026 with an exchange rate between 18.0 and 18.5 against the U.S. dollar, which would be around its range for the past two months. 

Mexico economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2026. Monetary policy is the Bank of Mexico’s year-end target for the overnight interbank rate.} 

^{Source: Vanguard.}

United Kingdom

BoE likely to cut rates further after budget release

“The U.K. budget was, on balance, good news for growth and inflation in 2026 and will pave the way for more Bank of England rate cuts.” Shaan Raithatha, Vanguard Senior Economist

The U.K. budget, released November 26, was, on balance, good news for growth, inflation, and fiscal sustainability. Most of the £26 billion worth of tax increases will come from 2028 onward, while day-to-day spending will rise modestly in the near term. We recently upgraded our 2026 GDP forecast by 0.2 percentage points to 1%.

A large chunk of the gap between current inflation and the 2% Bank of England (BoE) target is due to regulated prices, including energy and water bills. We forecast U.K. inflation to fall sharply in 2026 as the government’s announced policy measures directly lower energy prices and challenging year-earlier comparisons for some of these components unwind.

The BoE cut the bank rate again in December, to 3.75%. We expect the rate will be cut twice more in 2026, with the next cut likely in April. Accordingly, we expect the bank rate to end 2026 at 3.25%, which is around our assessment of the neutral rate, or the rate that would neither stimulate nor restrict economic activity.

United Kingdom economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Prices Index, excluding volatile food, energy, alcohol, and tobacco prices, as of December 2026. Monetary policy is the Bank of England’s bank rate at year-end.}

^{Source: Vanguard.} 

Euro area

ECB to keep rates at 2% throughout 2026

“Don’t expect a strong AI-driven investment impulse in 2026. We anticipate that capital expenditure from Europe’s tech sector over the next two years will be no more than $300 billion, well below the $2 trillion expected in the United States.” Shaan Raithatha, Vanguard Senior Economist

The euro area has experienced a soft landing. Annual inflation ended 2025 at the 2% target set by the European Central Bank (ECB) after peaking above 10% in late 2022. Meanwhile, the economy is growing close to its potential, and the unemployment rate is at its lowest sustained level since the creation of the euro in 1999. The ECB halted its easing cycle in June 2025, leaving the deposit facility rate at 2%, down from a peak of 4% in 2024. We expect it to stay at 2% throughout 2026.

Meanwhile, fiscal policy is taking center stage. Germany is now set to run annual budget deficits of close to 4% of GDP over the next decade. Additionally, defense spending across the European Union will ramp up this year and is expected to meaningfully contribute to growth.

However, we do not expect a strong AI-driven investment impulse in 2026. Anticipated capital expenditure from the European Union’s tech sector over the next two years is around $250 billion to $300 billion, compared with over $2 trillion in the U.S. Accordingly, we expect real private investment growth of just 2% in the euro area in 2026, compared with 7% in the U.S.

Euro Area economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Harmonised Indexes of Consumer Prices, excluding volatile energy, food, alcohol, and tobacco prices, as of December 2026. Monetary policy is the European Central Bank’s deposit facility rate at year-end.}

^{Source: Vanguard.}

Japan

Continued policy normalisation on a steady growth path

“Resilient domestic demand and favorable wage dynamics anchor stable growth amid policy normalisation.” Grant Feng, Vanguard Senior Economist

We expect Japan’s economy to remain on a steady path toward normalisation in 2026, despite lingering tariff-related uncertainty and political turbulence. (The ruling party’s secretary general said on January 14 that the prime minister plans to dissolve parliament and call a snap election, potentially as early as February.) Domestic demand remains resilient, with private consumption continuing to recover amid persistent inflationary pressures.

We forecast solid real GDP growth of 1% in 2026 and expect private consumption to remain firm, driven by strong wage growth and the positive impact of permanent income tax cuts. Capital spending should continue its upward momentum, supported by elevated corporate earnings. Exports are likely to post moderate growth, aided by a resilient U.S. economy and a weak yen, with the impact of U.S. tariff hikes proving limited thus far.

The Bank of Japan (BoJ) raised its policy rate by one-quarter of a percentage point to 0.75% at its December meeting, signaling growing confidence in sustained inflation and a commitment to continued policy normalisation. We expect the BoJ to raise the rate to 1% by the end of 2026, with an eventual move toward 1.5%, our estimate of the neutral rate. (The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.) We expect the pace of future hikes to be measured, contingent on wage negotiations, domestic demand trends, foreign exchange volatility, and global uncertainties.

On the fiscal side, larger-than-expected expansion under the new administration, combined with solid domestic demand and persistent inflationary momentum, is set to fuel underlying price pressures while raising concerns about fiscal sustainability over the medium term.

Japan economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile fresh food prices, as of December 2026. Monetary policy is the Bank of Japan’s year-end target for the overnight rate.} 

^{Source: Vanguard.} 

China

AI to drive near-term growth, but upside is limited

“Faster AI adoption in China will boost real growth in the near term, but the upside potential is limited for future capital deepening and productivity gains. Structural headwinds are strong, and AI alone won’t be enough to lift the economy.” Grant Feng, Vanguard Senior Economist

2026 marks the start of China’s 15th Five-Year Plan, with policymakers emphasising technological innovation and manufacturing upgrades. We expect GDP growth to ease modestly to 4.5% in 2026, with tariff drags partly offset by a rebound in manufacturing and infrastructure investment. 

China’s AI development appears faster but less impactful than that of the U.S. Its frontloaded strategy is driven by a strong digital ecosystem, robust energy infrastructure, greater AI acceptance, aggressive government funding, and a vast talent pool in industries related to science, technology, engineering, and mathematics. These factors imply upside risk in the near term. However, we see more limited upside potential for capital deepening and productivity gains. Efficient models and strong infrastructure reduce the need for heavy investment, and China’s labour market is significantly less exposed to potential AI automation due to a far greater concentration of jobs in agriculture, manufacturing, and construction compared with the U.S.

The annual Central Economic Work Conference in December reaffirmed policy commitments to bolster domestic consumption through household income growth alongside traditional investment support. However, the degree to which these measures may address structural imbalances remains uncertain. Rebalancing toward consumption and social welfare spending is likely to be gradual, limiting near-term impact. External headwinds also weigh on the outlook, with subdued global demand and lingering tariff effects constraining export performance. As a result, supply-and-demand mismatches may persist well into 2026.

The People’s Bank of China kept loan prime rates unchanged at its fourth-quarter 2025 meeting, reinforcing its commitment to steady liquidity conditions and selective easing. In 2026, we expect only modest policy-rate cuts that amount to 20 total basis points. (A basis point is one-hundredth of a percentage point.)

China economic forecasts

^{Notes: GDP growth is defined as the annual change in real (inflation-adjusted) GDP in the forecast year compared with the previous year. Unemployment rate is as of December 2026. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2026. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end.} 

^{Source: Vanguard.} 

^{About the Vanguard Capital Markets Model}

^{The asset-return distributions shown here are in nominal terms—meaning they do not account for inflation, taxes, or investment expenses—and represent Vanguard’s views of likely total returns, in U.S. dollar terms, over the next 10 years; such forecasts are not intended to be extrapolated into short-term outlooks. Vanguard’s forecasts are generated by the VCMM and reflect the collective perspective of our Investment Strategy Group. Expected returns and median volatility or risk levels—and the uncertainty surrounding them—are among a number of qualitative and quantitative inputs used in Vanguard’s investment methodology and portfolio construction process. Volatility is represented by the standard deviation of returns.}

^{IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.}

By Vanguard
January 28
vanguard.com.au