Investment and economic outlook, February 2026

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Australia

A rate hike after a short easing cycle

“With the economy operating near full capacity and inflation proving persistent, the Reserve Bank of Australia is expected to lean more heavily into its price-stability objective, maintaining a ‘higher-for-longer’ stance.” Grant Feng, Vanguard Senior Economist

Australia’s economic challenge remains heavily supply driven. Weak productivity growth has lowered the economy’s potential growth rate. The unemployment rate, at 4.1%, sits below the Reserve Bank of Australia (RBA) full-employment estimate, and capacity utilisation is well above its long-run average. As a result, even a moderate recovery in private demand and GDP could stall the disinflationary momentum observed last year.

We expect trimmed mean inflation to remain above the RBA’s 2%–3% target band in coming quarters, though gradual moderation is likely as tighter policy works through the economy.

Given this backdrop, we expect the RBA to lean more heavily into its price-stability objective, maintaining a “higher-for-longer” stance. The RBA raised the policy rate to 3.85% on February 3, and we foresee the rate ending the year at that level. Policy from here will be increasingly data dependent. Any further adjustments will hinge on whether underlying inflation is credibly moving back toward target or instead exhibiting signs of renewed persistence.

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

Less urgency, more Federal Reserve caution

“We see a firming labour market ahead, and with the federal funds rate now aligned with a range of neutral estimates, we expect less urgency and a more cautious approach to easing from the Federal Reserve.” Josh Hirt, Vanguard Senior U.S. Economist

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 estimates, we expect the Federal Reserve to become more cautious about easing. (The neutral rate is the interest rate that would neither stimulate nor restrict economic activity.)

U.S. 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.

Job creation has cooled considerably over the past year. Even so, we believe the underlying labour backdrop remains stable. We assess that demographic dynamics and immigration flows explain about 70% of a recent hiring slowdown, rather than a deterioration in labour demand. We see the unemployment rate firming toward 4.2% by the end of 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.} 

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

Canada

Resilience amid geopolitical crosscurrents

“Canada begins 2026 navigating renewed geopolitical hazards, but domestic fundamentals provide a steadying counterweight.” Adam Schickling, Vanguard Senior Economist

Canada starts 2026 navigating a familiar set of geopolitical hazards that continue to shape, and sometimes complicate, its domestic economic outlook. Recent easing of select tariff disputes with China have added to frictions with the United States, while trade-related economic uncertainty is suppressing business investment. 

Despite these disruptions, the Canadian consumer appears poised to maintain the strength that anchored much of the economy’s resilience in 2025. January’s labour force data show the unemployment rate falling to 6.5%, not because of robust hiring but due to a contraction in labour force participation—an early sign of the demographic slowdown expected to shape the next few years. Rising full-time employment, real wage growth, limited job losses, and positive wealth effects from the financial markets should keep a solid floor under consumption, helping offset soft business investment.

Fiscal policy will add a modest tailwind through targeted sectoral initiatives and ongoing infrastructure programs. Paired with expectations for above‑trend global growth, we forecast Canada’s real GDP to expand by 1.8% in 2026. Core inflation eased through late 2025, giving the Bank of Canada (BoC) room to cut rates by a cumulative 100 basis points last year. (A basis point is one-hundredth of a percentage point.) 

However, with inflation still slightly above target and underlying wage growth proving sticky, policy now appears firmly set at neutral. The BoC held its policy rate at 2.25% in January 2026, striking a balanced tone as it weighs softer hiring against gradually improving macro conditions. Barring an unforeseen shock, we see little rationale for additional rate moves in either direction this year.

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.}

Mexico

Structural strengths to anchor a cyclical upswing

“We expect Mexico’s economy to experience a cyclical upswing in 2026, anchored by its structural strengths in North America.” Thiago Ferreira, Vanguard Senior Economist

Mexico enters 2026 recovering from cyclical challenges and facing longer-term economic opportunities. After a sluggish year marked by tariff uncertainty and fiscal consolidation, we expect GDP to rebound in 2026, supported by strong demand from the U.S., a resilient labour market, and a sizeable minimum wage increase affecting millions of workers. Tourism related to soccer’s World Cup will also lift economic activity. 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. We expect that the midyear review of the United States-Mexico-Canada Agreement will boost business and consumer sentiment, although it is also likely to generate bouts of uncertainty. 

While inflationary pressures remain uneven, we expect a gradual decline in inflation. Lingering cost pressures—including new taxes and tariffs in select categories—and sticky core inflation are near-term challenges. In contrast, contained real wage growth, stable long-run inflation expectations, and the past appreciation of the peso should help push inflation lower. Overall, we expect core inflation to ease to 3.7% by year-end. 

On the monetary policy front, the Bank of Mexico (Banxico) is in an easing cycle that should bring the policy rate to 6.5% by year-end, supporting credit-sensitive sectors and household consumption. With disinflation proceeding only gradually, the approach to cuts remains cautious rather than aggressive. Banxico maintained the policy overnight interbank rate at 7% in early February, signaling a data-dependent approach to normalisation.

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 would be weaker than current levels but stronger than its levels for much of 2025.

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.}

United Kingdom

Dovish tone sets the stage for a March rate cut

“A dovish tone at the Bank of England meeting in early February has set the stage for a March rate cut, after the Monetary Policy Committee slashed its two-year-ahead inflation forecast from 2.1% to 1.8%.” Shaan Raithatha, Vanguard Senior Economist

We expect U.K. real income growth to moderate further amid a weak labour market in 2026. Meanwhile, fiscal policy will be modestly supportive of activity as day-to-day departmental spending ramps up. We don’t expect a strong AI-driven impulse to investment, unlike in the United States. Our 2026 GDP growth forecast for the U.K. is 1%.

We anticipate that U.K. inflation will fall sharply in 2026, as base effects—unfavourable year-earlier comparisons—unwind and government measures result in lower energy prices. 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.}

^{Source: Vanguard.} 

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

Euro area

German fiscal policy key to the Euro area outlook

“After a prolonged downturn since 2018, German industry is finally showing signs of bottoming out. New orders have accelerated, partly driven by defence-related sectors.” Shaan Raithatha, Vanguard Senior Economist

The growth outlook in 2026 will be shaped by two opposing dynamics. The first is the headwind from higher U.S. 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 defence spending throughout the European Union (E.U.). 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. We anticipate a further 0.2-point lift to euro area GDP from increased defence spending by other E.U. nations.

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 defence-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% through 2026. That’s our assessment of neutral, or the rate that would neither stimulate nor restrict economic activity. But we judge risks as skewed toward 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 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.}

Japan

The prospects for policy rate hikes improve

“The Bank of Japan is moving away from its previously cautious posture and toward a preference for steady, incremental rate increases.” Grant Feng, Vanguard Senior Economist

Japan’s economy remains on a steady path toward 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 from a government that received an emphatic vote of confidence in February 8 snap elections. Corporate profits continue to be strong. We anticipate that software investments will address labour shortages and research and development spending will drive capital expenditure growth. We don’t see major risks to the domestic economy, as solid demand stems from a structural shift to a labour-shortage economy with continued high wage growth.

Underlying inflation continues to rise moderately. Although wage growth is likely to slow in 2026 compared with 2025 through nationwide negotiations, 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 emphasized that exchange rate movements are exerting a greater influence on domestic prices. This development reflects a structural shift in corporate behavior, 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.} 

^{Source: Vanguard.} 

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

China

A two-speed economy extends into 2026

"Weak domestic demand amid resilient external performance was a defining feature of China’s economy in 2025. Increasing investment in high-tech and strategic sectors may not fully offset the structural downturn in property investment.” Grant Feng, Vanguard Senior Economist

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. The government has expanded childbirth subsidy programs, but these measures appear insufficient to reverse the downward trend. China’s newborn population fell to 7.92 million in 2025, the lowest number since records began in 1949.

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 toward a consumption-driven growth model, domestic demand is likely to remain weak.

Authorities have become increasingly concerned about demand, and a new round of policy support has begun. Fiscal measures—including the frontloading of government spending—have been implemented, while monetary authorities recently introduced targeted rate cuts, increased liquidity quotas for priority sectors, and lowered commercial mortgage down-payment thresholds. However, more policy support will be required to prevent further growth deceleration in 2026. The policy stance will likely remain gradual and targeted. Additional property‑support measures are possible, although a broad, comprehensive rescue package still appears some distance away.

The People’s Bank of China has kept rates and liquidity settings steady, emphasizing 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.} 

Vanguard. 
25 Feb 2026
vanguard.com.au/