Global inflationary pressures test central banks’ resolve

Key points

• Central banks are balancing inflation risks with a softer growth backdrop.

• Inflation remains elevated, driven by energy shocks in Europe and price pressures in US services.

• Structural divergences are shaping regional growth dynamics.

United States

Trajectory of inflation to constrain policy

At the halfway point of the year, our US economic outlook remains constructive, supported by exceptional strength in AI-led business investment, a firmer-than-expected pace of job creation and a consumer who has remained resilient despite higher energy prices and cooling wages.

That said, price pressures have reemerged as a factor, and we have upgraded our year-end core inflation estimate above 3%. This upward revision is driven by sticky services inflation and a range of potential one-off factors, including the lingering effects of tariff pass-through, energy price increases owing to the conflict in the Middle East and the likely overstatement of AI-related category inflation.

We continue to view the labour market as fundamentally healthy. We anticipate a summer slowdown in hiring activity, which could push the unemployment rate higher. Looking further out, we expect the unemployment rate to stabilise in the mid-4% range.

In this environment, we anticipate that the US Federal Reserve will be constrained, even with a range of views on the Federal Open Market Committee about inflation and the labour market. We have removed our previously expected rate cut for 2026 and now expect that the policy rate will remain in its current range through to 2027.

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.

United Kingdom

Soft data skew risks towards fewer rate hikes

The continuing energy shock remains the key driver of our UK outlook. The economy stands on firm footing after a strong first quarter, leading us to recently upgrade our 2026 growth forecast to 1.1%. We see this momentum carrying through to early in the second quarter.

However, we anticipate a slowdown in the second half of the year as higher energy costs and tighter financial conditions weigh on activity. Conditions will likely ease throughout 2027, and we forecast 1.2% growth for next year as monetary policy relaxes back towards current levels after some near-term tightening later this year.

Prices are accelerating amid the Middle East conflict. Inflation expectations remain elevated given sticky inflation levels since 2022, and there is some evidence that firms may be passing on higher input costs to consumers. That said, with a weak labour market and a recent soft spot in inflation data, risks to our call for two hikes from the Bank of England now skew towards less tightening.

The outlook for fiscal policy is highly dependent on the next prime minister. Someone with a desire to increase public spending would be good for the economy in the short term but may lead to a sharp tightening in financial conditions amid potential concerns about fiscal credibility, which would weigh on growth in the medium term. 

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 hike twice this year amid inflation concerns

Our euro area outlook is driven by German fiscal expansion and the continent’s high exposure to the Middle East conflict. Early indicators point to a loss of momentum, with first-quarter growth down and survey data suggesting weakness in the services sector.

Since the start of the year, we have revised our 2026 GDP forecast down from 1.2% to 0.8%, reflecting the drag from higher energy prices and trade disruption. We expect growth to recover to 1.3% in 2027 as the impact of the energy shock fades and German investment accelerates.

Data is beginning to reveal the true impact of the conflict in the Middle East. Input prices are rising quickly, and supply chains are facing disruption. However, we do not anticipate significant additional pass-through to inflation from wages and price-setting behaviour beyond the direct effect of the energy shock.

We anticipate that the European Central Bank will deliver two hikes this year. The Governing Council has highlighted the importance of a risk-management approach to lean against long-term inflation risks from the Middle East conflict. As the shock unwinds, we expect policy to normalise, with two cuts in 2027.

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

Rate-hike bias hinges on economic data, geopolitics

Despite the heightened uncertainty of the Middle East conflict, GDP sharply exceeded expectations in the first quarter, driven mainly by exports and consumption. Meanwhile, capital expenditures are holding firm, supported by strong corporate earnings and labour-saving investment demand. The strong first-quarter results do not fully reflect the impact of the Middle East conflict, however, as higher energy prices are likely to weigh on consumption and capital spending.

Beyond that, the upswinging AI cycle and energy subsidies will partly offset the growth drag from energy headwinds. Although inflation slowed sharply in April, partly due to institutional factors such as food-price controls, we expect the impact of higher oil prices and yen weakness to gradually emerge as upside pressure.

As the Bank of Japan (BoJ) has pointed out, firms are becoming more willing to pass on higher costs through higher prices. As a result, we expect core inflation to recover above 2%.

Amid sustained wage growth, the BoJ is laying the groundwork for a gradual resumption of policy tightening this year. We continue to expect two further rate hikes by the end of 2026, taking the policy rate to 1.25%. Timing will be data‑dependent, hinging on 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.

China

Supportive conditions for growth amid wider imbalances

China’s economy is finding support from relatively new and more traditional sources, even as imbalances have widened. The AI boom and green transition provide structural support, as do resilient exports, which are up around 15% in the first four months of 2026. More stable US trade relations after the recent leadership summit in Beijing should continue to support the external outlook.

Even so, growth imbalances have widened, with supply-side momentum and investment remaining firm while consumption has softened and real estate remains a drag. A meaningful domestic-demand turnaround remains elusive, held back by labour market softness, limited policy rebalancing towards consumption, and the ongoing adjustment in the real estate sector.

While higher energy prices, solid growth and tentative improvement in the real estate market are driving a mild rebound in prices, the recent reflation impulse lacks a strong driver as the two-speed economy becomes more entrenched. Energy price pressures and persistent supply-chain strains are pushing up producer and input prices at the margins, aiding price recovery. However, pass-through to consumer inflation remains limited given subdued household demand.

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.

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 March 2026.

Our 10-year annualised nominal return projections ¹, expressed for local investors in local currencies, are as follows:

United Kingdom (British pounds)

Euro area (euro)

Switzerland (Swiss francs)

¹ 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.