Global inflationary pressures test central banks’ resolve

Key points

• Energy prices are pushing inflation higher, complicating the outlook across major economies.
  
  
• Central banks are turning more cautious, focused on preventing a rise in inflation expectations.
  
  
• Growth remains resilient – but is likely to slow as higher costs and tighter conditions feed through.

United States

A constructive outlook with a close eye on inflation

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

The labour market looks healthy, but growth is slowing. Strong job creation in health care continues to reflect structural demand, a trend we expect to persist in 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 pass-through of tariffs and early energy-spike effects from conflict in the Middle East. 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, conflict in the Middle East and high energy prices will bias the US Federal Reserve towards 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. 

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

BoE to raise rates to lean against inflationary pressures

Conflict in the Middle East remains key to the UK 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 1.1% in 2026. While growth is still set to soften over the rest of the year, as higher energy costs and tighter financial conditions weigh on activity, the stronger starting point leads us to revise our forecast up from 0.6%. 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 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. These hikes are likely to materialise later than in the euro area, given 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.

Euro area

ECB to deliver ‘insurance hikes’ in 2026

Like the UK, the euro area is more exposed to the conflict in the Middle East relative to the US and China because it is a net energy importer. Higher energy prices are expected to slow growth and push up inflation. 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.

Data suggests higher energy prices are feeding into consumer prices and that 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 to raise rates by 50 basis points in 2026, with the first increase coming as early as June. We see these as ‘insurance hikes.’ The Governing Council has said that it will adopt a risk management approach to lean against potential effects from the Middle East shock. We expect policy to reverse and two cuts to materialise 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 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

A hawkish pause with a hiking bias

Conflict in the Middle East 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 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, which are poised to deliver average pay increases above 5%. This development reinforces Bank of Japan confidence that inflation is durable amid a tight labour market.

Beyond that, AI in a growth phase 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, suggesting a central bank pause and allowing fiscal tools (e.g. fuel subsidies) to absorb the shock – unless it proves persistent.

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

When energy headwinds meet AI tailwinds

China’s economic growth strongly outperformed expectations in Q1, driven by resilient exports, frontloaded fiscal support, and so far limited spillover from conflict in the Middle East.

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 higher energy costs.

Although deflationary pressures have eased, 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 towards 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.

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 projections¹, 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.