investment and economic outlook 2026

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

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Economic outlook for Australia

RBA tightens as inflation risks intensify

“With energy prices set to push inflation higher, the Reserve Bank of Australia is signaling a clear intent to push policy into restrictive territory to curb demand and re anchor inflation expectations.”

—Grant Feng, Vanguard Senior Economist 

The Middle East conflict has lifted oil prices and intensified supply side cost pressures, and that’s feeding into consumer prices. But the impact on economic growth is more nuanced. Because Australia is a large net energy exporter, higher commodity prices should boost national income through stronger terms of trade, partially cushioning any growth drag. On balance, and considering Australia’s heavy oil dependence, limited petroleum reserves, and tighter financial conditions, we have downgraded our 2026 GDP growth forecast by 20 basis points to 1.8%. (A basis point is one-hundredth of a percentage point.)

Australia’s economic challenge remains predominantly supply driven. The economy has been running beyond its sustainable capacity, with the unemployment rate below estimates of full employment. This raises the risk that elevated inflation becomes embedded in expectations, which is arguably a more pressing concern than it would be in other major economies.

With energy prices rising further to date in the second quarter, near term inflation risks clearly skew to the upside. Three consecutive interest rate hikes (in February, March, and May) suggest a shift by the Reserve Bank of Australia (RBA) from a follower to a first mover. Although indicators of economic sentiment have deteriorated, the RBA appears increasingly focused on its price stability mandate. The priority is clear: Prevent inflation from becoming entrenched and avoid a repeat of the 2022 policy misstep, when inflation materially overshot the RBA’s target.

Whether the RBA tightens further will hinge on how quickly the economy weakens. The combination of higher rates and rising fuel costs has already triggered a sharp deterioration in sentiment, suggesting a downturn may be underway. Our base case is that the RBA pauses to year-end, contingent on clearer evidence of slowing demand and labour market softening. However, if the economy proves more resilient than expected, the risk of an additional hike remains firmly on the table.

Australia economic forecasts
 
GDP Growth

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. 

Capital Markets Model® forecasts

Our 10-year annualised nominal return and volatility forecasts are based on the 31 March 2026 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 March, 2026. 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.

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for the United States

A constructive outlook with a close eye on inflation

“Inflationary pressures have remained elevated early in the year, while the Federal Open Market Committee’s bias to ‘look through’ recent price pressures appears to have narrowed.”

—Josh Hirt, Vanguard Senior U.S. Economist

The U.S. economic outlook remains constructive, supported by continued strength in business investment and generally resilient household demand. That said, energy prices have remained elevated. We’d need to see some near-term moderation for recent economic trends to continue. 

We continue to view the labour market as fundamentally resilient, albeit transitioning toward a slower growth phase. Heavily concentrated job creation in health care continues to reflect structural demand in health care services, a trend we expect to persist over the coming years. We continue to see AI related displacement as a limited risk in 2026.

Inflation has remained stubbornly elevated early in the year, prompted by continued pass-through of tariffs and early energy-spike effects from the Middle East conflict. We expect elevated non housing services inflation to moderate in the months ahead. Should that remain sticky, it will be difficult for core inflation to fall below 3% this year.

For now, continued conflict in the Middle East and high energy prices will bias the Federal Reserve toward inaction, although elevated inflation will keep the central bank vigilant to potential changes in inflation expectations. We retain our expectation for a single policy rate cut in 2026, consistent with where we anticipate a narrowed and slim bias of the Federal Open Market Committee to remain. 

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 rounded midpoint of the Federal Reserve’s target range for the federal funds rate at year-end.

Source: Vanguard. 

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for Canada

Solid growth despite increasing headwinds

“Canada’s economy has remained resilient through a period of significant uncertainty, with strong export performance helping offset emerging headwinds from softer hiring and higher energy costs.”

—Adam Schickling, Vanguard Senior Economist

Continued resilience in export-oriented industries and supportive fiscal policy have Canada’s first-quarter GDP growth tracking at 1.7%, extending the better-than-expected momentum from 2025. A key driver has been the breadth of United States-Mexico-Canada Agreement (USMCA) tariff exemptions, which have preserved a relative advantage versus other U.S. trading partners on about three-quarters of Canadian exports. We expect these exemptions to remain a modest tailwind through 2026, even as the USMCA renegotiation window opens midyear.

Consumer resilience has been another cornerstone of Canadian economic strength since last year’s U.S. tariff announcements, though signs of moderation are emerging. Employment growth has softened, and the unemployment rate has risen to 6.9%. While the composition of unemployment among younger and less-tenured workers tempers the near-term impact on consumption, continued housing market weakness is likely to amplify negative wealth effects. As a result, consumer spending should become more sensitive to real income growth, which we expect to soften alongside the labour market and amid rising energy costs.

On the external front, elevated uncertainty and the energy price shock associated with the Middle East conflict has dampened global growth expectations. While Canada is among the few advanced economies we expect will see a modest near term GDP boost from higher oil prices, these benefits can be offset by declining external demand and Canadian household cost pressures from prolonged higher energy costs. These elevated energy prices also represent an inflationary shock, raising headline price pressures and the risk that disinflation stalls, complicating the near term monetary policy outlook. Although risks have tilted modestly toward a rate hike, we continue to expect no change in policy rates through 2026.

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.

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for Mexico

Recovery continues amid more uncertain global environment

“Mexico’s structural strengths should help sustain recovery in 2026 despite a more uncertain global environment.”

—Thiago Ferreira, Vanguard Senior Economist

The conflict in the Middle East has elevated both commodity prices and uncertainty about the economic outlook. Mexico’s exposure is mainly indirect, operating through higher global energy costs—particularly refined petroleum products and natural gas—rather than direct supply links to the region. Still, we have revised our GDP growth forecast downward and our inflation forecast upward. A prolonged conflict would pose further upside risks to inflation, downside risks to growth, and depreciation pressure on the peso.

GDP contracted by 0.8% in the first quarter on the back of disappointing services and industry sectors. Household consumption, an important driver of growth last year, has shown less momentum, as have some high-frequency indicators for the second quarter. We continue to expect GDP to post a modest rebound in 2026, supported by solid demand from the U.S. and a resilient labour market. 

We anticipate that the midyear review of the United States-Mexico-Canada Agreement on trade will influence sentiment, though negotiations may generate bouts of volatility. Recent U.S.-Mexico engagement has advanced into a bilateral negotiating track—with an agreed-upon first official negotiating round during the week of May 25—including discussions on rules of origin, economic security, and critical minerals.

Although inflationary pressures remain uneven, we expect a gradual decline in the pace of inflation. Headline inflation has moved higher recently, driven largely by non core components. Given the recent developments in global energy markets, we have raised our year end 2026 core inflation forecast to 4.1%. Contained real wage growth, stable long-run inflation expectations, and the past appreciation of the peso should help push inflation lower over time, although higher energy prices remain an upside risk. 

After making a 25-basis-point cut to the overnight interbank rate in late March, the Bank of Mexico lowered the rate by 25 basis points again on May 7—to 6.5%—citing near term economic weakness and the evolving inflation outlook. (A basis point is one-hundredth of a percentage point.) As disinflation is proceeding only gradually, the approach to further cuts remains cautious.

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 17.5 and 18.5 against the U.S. dollar, which is slightly above the level seen for most of the past month.

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. 

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for the United Kingdom

BoE to raise rates to lean against inflationary pressures

“Against the backdrop of a soft labour market, any interest rate increases in 2026 should be viewed as ‘insurance hikes’ for risk management purposes. The Monetary Policy Committee has given a clear signal that it views the magnitude of second-round effects from conflict in the Middle East to be lower than during the 2022 Ukraine shock given the current weakness in the labour market.”

—Shaan Raithatha, Vanguard Senior Economist

The Middle East conflict remains front and centre for the U.K. economic outlook. Compared with the Ukraine shock in 2022, the labour market is looser, wage growth is softer, and inflation is starting from a lower level. We forecast GDP growth of 0.6% in 2026, down 0.4 percentage points from our forecast prior to the outbreak of hostilities in the Middle East, reflecting tighter financial conditions and a drag from higher energy prices. This forecast assumes a scenario in which oil prices average $90–$100 per barrel for one to two quarters.

Early evidence suggests higher energy prices are feeding into consumer prices quickly, with annual Consumer Prices Index (CPI) inflation rising from 3.0% in February to 3.3% in March. Moreover, medium-term inflation expectations have edged up. Accordingly, we have upgraded our 2026 headline CPI forecast by 0.8 percentage points to 3.6%. We expect core inflation to finish the year at 2.8%.

We also now anticipate that the Bank of England (BoE) will raise rates by 50 basis points in 2026 and that these hikes are likely to materialize later than in the euro area. This is because the BoE was in cutting mode before the Middle East conflict and the policy rate is still marginally restrictive at 3.75%.

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. 

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for the euro area

ECB to deliver “insurance hikes” in 2026

“With consumer prices now rising sharply and supply chains being disrupted, the European Central Bank is set to deliver interest rate increases. This risk management approach will lean against inflation becoming embedded in wage- and price-setting behaviour further down the track.”

—Shaan Raithatha, Vanguard Senior Economist

The euro area is relatively exposed to the Middle East conflict as it is a net energy importer. Our 2026 GDP growth forecast is 0.8%, down 0.4 percentage points from our pre-conflict forecast, as we expect higher energy prices and tighter financial conditions to slow economic activity. This forecast is conditional on a scenario in which oil prices average $90–$100 per barrel for one to two quarters.

Early evidence suggests the direct impact of higher energy prices is feeding into consumer prices quickly and supply chains are being disrupted. However, the magnitude of second-round effects is likely to be weaker than with the 2022 Ukraine shock. This is because the euro area came into this latest shock from a position of relative strength, with headline inflation close to 2%, inflation expectations well anchored, and a labour market that was not particularly tight.

We now expect the European Central Bank (ECB) to raise rates by 50 basis points in 2026, with the first increase coming as early as its June meeting. We see these as “insurance hikes.” The Governing Council has articulated that it will adopt a risk management approach to lean against potential second-round effects from the Middle East shock. We expect policy to reverse and two cuts to materialize in 2027 as the energy shock fades.

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 Harmonized 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. 

Note: All investing is subject to risk, including the possible loss of the money you invest. 

Economic outlook for Japan

A hawkish pause with a hiking bias

“The Bank of Japan appears to be transitioning from a highly cautious posture to one that favours steady and incremental policy normalisation.”

—Grant Feng, Vanguard Senior Economist

The Middle East conflict poses the greatest growth headwind to Japan given the country’s large exposure to imported energy. This headwind is likely to weigh on growth momentum in business fixed investment and household consumption. Although the economic impact isn’t negligible, it appears to be manageable, reflecting Japan’s ample oil reserves, improved energy efficiency, and structural resilience. Risks would rise materially with weaker global demand or sustained supply disruptions.

Meanwhile, economic fundamentals for future interest rate tightening remain in place. Of particular importance are the annual union wage negotiations—known as Shunto—which are again poised to deliver average pay increases above 5%. This development reinforces Bank of Japan (BoJ) confidence that inflation is durable amid a tight labour market. 

Beyond that, AI in an upswinging cycle and fiscal expansion in the form of energy subsidies should partly offset the growth drag from energy headwinds, helping to buttress trend growth.

Higher energy costs are a double edged sword. They add to inflation but also weigh on real growth through deteriorating terms of trade, thus arguing for a central bank pause and allowing fiscal tools (e.g., fuel subsidies) to absorb the shock—unless it proves persistent.

With sustained wage growth, the BoJ is laying the groundwork for a gradual resumption of policy tightening this year, having not increased the overnight rate since December 2025. We continue to expect two further rate hikes by the end of 2026, which would take the policy rate to 1.25%. Timing will be data dependent, hinging on incoming inflation, wage, and activity data, as well as the persistence of the energy shock. 

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. 

Note: All investing is subject to risk, including the possible loss of the money you invest.

Economic outlook for China

When energy headwinds meet AI tailwinds

”China is better cushioned, though not immune, from the oil shock as higher energy prices still pose risks through adverse terms of trade and downstream margin compression. At the same time, an upswinging AI cycle is providing a strong offset to external shocks.”

—Grant Feng, Vanguard Senior Economist

China’s economic growth strongly outperformed expectations in the first quarter, driven by resilient exports, frontloaded fiscal support, and so far limited spillover from the Middle East conflict. However, a K-shaped divergence widened. The supply side continued to outperform, with industrial production beating consensus by a wide margin, consistent with strong export momentum. That supply side strength reflects resilience in advanced manufacturing and AI linked sectors, supported by policy backing and solid external demand. In contrast, domestic demand disappointed modestly, as retail sales softened.

China is better cushioned, though not immune, from the oil shock as higher energy prices still pose risks through adverse terms of trade and downstream margin compression. The government may continue to frontload budgetary expenditures, and China could gain export market share in selected industries. But these forces offer only a partial offset to softer global demand and deteriorating terms of trade amid elevated energy costs.

Although deflationary pressures have eased materially, driven largely by higher energy prices, the oil shock alone cannot reflate the Chinese economy on a sustainable basis without a notable recovery in demand. Companies are absorbing higher input costs and not passing them on because domestic demand is weak.

The stronger than expected start to 2026 reduces the urgency for further near term stimulus. The emphasis is likely to shift toward policy implementation rather than rapid escalation. We see the People’s Bank of China as likely to remain on hold this year, with a preference for structural tools for targeted sectors rather than a broad-based policy rate cut.

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. 

Note: All investing is subject to risk, including the possible loss of the money you invest.

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.