Key points

• Cooling inflation is giving central banks scope to proceed more cautiously.
  
  
• Economic momentum is increasingly uneven across regions, from US investment‑led strength and UK disinflation to European fiscal support, Japan’s policy normalisation and China’s two‑speed economy.
  
  
• Together, these dynamics point to a more measured and selective global outlook, rather than a broad‑based, synchronised upswing.

United States

Less urgency, more Fed caution

The January Federal Open Market Committee meeting provided further evidence that monetary policy will proceed more cautiously in 2026. Our baseline expectation is for firm growth ahead, and with the federal funds rate now aligned with a range of neutral estimates¹, we expect the Federal Reserve to become more cautious about easing.

US economic momentum continues to be anchored by robust capital outlays, which have played a central role in driving growth over the past year. We expect business investment to remain a major source of strength in 2026. A significant part of this support comes from the rapid expansion of AI‑related spending, which we estimate to still be in the early stages.

Recent data have provided positive signs of continued disinflation. Some modest tariff-related impacts will still likely filter through early this year, and we expect core inflation to crest slightly above 3% before easing later in the year.

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.

Sources: Vanguard

United Kingdom

Dovish tone sets the stage for a March rate cut

We expect UK real income growth to moderate further amid a weak labour market in 2026. We don’t expect a strong AI-driven impulse to investment, unlike in the United States. Our 2026 GDP growth forecast for the UK is 1%.

We anticipate that UK inflation will fall sharply in 2026. The budget’s package to directly reduce household energy bills is expected to decrease inflation by 0.2 percentage points this year. We continue to expect headline inflation to drift down to 2.2% by the end of 2026.

A dovish tone at the Bank of England (BoE) meeting in early February has set the stage for a March rate cut. The Monetary Policy Committee reiterated that the risk of persistent inflation has continued to become less pronounced, and it slashed its two-year-ahead inflation forecast from 2.1% to 1.8%. We expect the BoE to reduce its policy interest rate twice in 2026, with the next cut now likely in March. We continue to anticipate that the bank rate will end 2026 at 3.25%.

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.

Sources: Vanguard

Euro area

German fiscal policy key to the euro area outlook

The growth outlook in 2026 will be shaped by two opposing dynamics. The first is the headwind from higher US tariffs, which we expect to reduce GDP by 0.3 percentage points. The second is looser fiscal policy, led by Germany’s infrastructure package and greater defense spending throughout the European Union (EU). We estimate that Germany’s fiscal loosening will boost German GDP by 0.5 percentage points in 2026 and euro area GDP by 0.2 points.

German industry has been in consistent decline for several years, but we are finally observing signs that activity has bottomed out. New orders have accelerated, partly driven by defense-related sectors. We continue to expect euro area growth of 1.2% in 2026, but risks now skew to the upside given the upturn in German activity.

We foresee the European Central Bank policy rate staying at 2% throughout 2026. That’s our assessment of neutral, or the rate that would neither stimulate nor restrict economic activity. But we judge risks as skewed towards further easing given the strength of the euro, moderating wage growth and the prospect of inexpensive Chinese exports being rerouted to Europe.

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.

Sources: Vanguard

Japan

The prospects for policy rate hikes improve

Japan’s economy remains on a steady path towards normalisation. We expect private consumption to remain firm, underpinned by strong wage growth, the positive effects of income tax cuts and the potential for a fiscal stimulus package. Corporate profits continue to be strong.

Underlying inflation continues to rise moderately. Although wage growth is likely to slow in 2026 compared with 2025, we foresee gains in the low 3% range. Against this backdrop, we expect labour-intensive service prices to rise and underlying inflation to remain intact, albeit with some volatility in the near term.

We anticipate that the Bank of Japan (BoJ) will remain committed to a gradual normalisation of monetary policy. Importantly, the BoJ has emphasised that exchange rate movements are exerting a greater influence on domestic prices. This development reflects a structural shift in corporate behaviour, as firms have adjusted wages and prices in response to external cost pressures. Given that the improving inflation dynamics are rooted in structural wage gains tied to persistent labour shortages, we expect two quarter-point rate hikes—which would raise the policy rate to 1.25%—by the end of 2026.

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.

Sources: Vanguard

China

A two-speed economy extends into 2026

China’s economy concluded 2025 on a softer footing, with real GDP growth easing to 4.5% year over year in the fourth quarter, the slowest pace since late 2022. Full‑year growth nonetheless met the government’s target of “around 5%”. Beyond cyclical factors, demographics are adding pressure. The total population declined for a fourth consecutive year.

We expect full-year GDP growth to slow to 4.5% in 2026 as China’s two‑speed economy persists, with resilient external performance accompanied by weak domestic demand. External demand is unlikely to remain the same growth engine as it was in 2025, however, given elevated global trade uncertainty. Without a meaningful shift towards a consumption‑driven growth model, domestic demand is likely to remain weak.

The People’s Bank of China has kept rates and liquidity settings steady, emphasising that additional easing will be selective. Credit growth is moderating, reflecting payback from earlier fiscal frontloading and softer household demand. We expect only a mild policy rate cut of 20 basis points, to 1.2%, by the end of this year to facilitate fiscal expansion. 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.

Sources: Vanguard

Asset-class return outlook

Vanguard has updated its 10-year annualised outlooks for broad asset class returns through the most recent running of the Vanguard Capital Markets Model® (VCMM), based on data as at 31 December 2025.

Our 10-year annualised nominal return projections², expressed for local investors in local currencies, are as follows:

¹ The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.

² The figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income.