Investment and economic outlook, July 2025

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Australia

Uncertainty, weak growth warrant a dovish central bank

“The Reserve Bank of Australia is cautiously dovish amid slow disinflation progress and downside risks related to heightened uncertainty.” Grant Feng, Vanguard Senior Economist.

While U.S. trade policy uncertainty is likely to weigh on Australian business confidence, downside risks to domestic activity are likely to be limited because of Australia’s low direct U.S. tariff exposure, commodities accounting for a high share of exports, and better-than-expected U.S.-China trade developments. We expect the Australian economy to grow by around 2% over 2025, with policy easing partly offsetting the impact of uncertainty.

We anticipate that inflation will stay within the 2%–3% band targeted by the Reserve Bank of Australia (RBA), though likely in the upper part of that band, at least in the near term. Supply-side weakness, especially lacklustre productivity growth, will continue to hold back progress on disinflation. Additionally, a tight labour market will likely continue to exert upward pressure on unit labour costs.

Modest domestic growth amid heightened global uncertainty is likely to weigh on consumer and business confidence. We expect a cautiously dovish RBA to cut its interest rate target from the current 3.85% to 3.35% by the end of the year.

Capital Markets Model® forecasts

Australia (Australian dollar)

^{IMPORTANT: The 10-year projections above regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Simulations as of May 31, 2025. For more information, please see the Notes section below.}

Australian 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 2025. Trimmed mean inflation is the year-over-year change in the Consumer Price Index, excluding items at the extremes, as of the fourth-quarter 2025 reading. Monetary policy is the Reserve Bank of Australia’s year-end cash rate target.}

^{Source: Vanguard.}

United States

A resilient first-half performance

“Inflation has continued to come in lower than expected. Our analysis finds that a primary cause has been the “frontrunning effect,” which has mitigated but not eliminated tariff pressures to date.” Josh Hirt, Vanguard Senior Economist.

The U.S. economy has remained resilient despite significant economic policy uncertainty through the first half of 2025. The labor market has gracefully decelerated so far this year and remains in a balanced position. It has averaged roughly 150,000 jobs per month over both the previous three months and the last year, highlighting an uncommon period of stability. Fiscal policy is now more certain with the recent passing of the One Big Beautiful Bill Act. We presently expect a modest boost to growth in 2026 in light of these circumstances, with deficit-impact concerns remaining a key focus of market participants.

Inflation data has continued to come in lower than expected by market participants. Our analysis finds that the primary cause has been the “frontrunning effect.” Despite a sharp rise in announced tariff rates, substantial import frontrunning early in the year has muted the inflationary impact and will likely continue to do so throughout 2025. However, the June Consumer Price Index report indicated accelerated increases in core goods prices, suggesting that companies are beginning to pass tariff costs on to consumers. We expect a modest pickup in core goods inflation in the second half and see the core Personal Consumption Expenditures price index ending 2025 around 3% year-over-year. It is worth noting that the frontrunning effect is not a free lunch—it has muted the near-term impact of increased tariffs but will modestly prolong their effects into 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 2025. 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 2025. Monetary policy is the upper end of the Federal Reserve’s target range for the federal funds rate at year-end.}

^{Source: Vanguard.}

China

After solid first-half growth, a slowdown in momentum is likely

“We expect China’s growth momentum to weaken given continued property softness, fading exports, and resilient but moderating consumption.” Grant Feng, Vanguard Senior Economist.

China’s economy demonstrated resilient growth in the second quarter, with real GDP expanding by a stronger-than-expected 5.2% year over year and a solid quarter-over-quarter increase of 1.1%. Given this strength, we have upgraded our full-year China GDP forecast from 4.6% to 4.8%. Growth was primarily underpinned by robust exports and frontloaded policy easing. A goods trade-in program has boosted consumption, and accelerated policy stimulus has supported economic growth. Exports have remained resilient in the face of U.S. tariffs, supported by frontloading and the rerouting of shipments. We expect external policy volatility to subside in the coming months, offering temporary relief to the export sector. Peak tariffs may be behind us, but headwinds remain, with the U.S. average tariff rate on China higher now than it was at the beginning of the year.

We expect China’s growth momentum to moderate in the second half. Positive impulses from frontloaded exports are likely to fade, while several sources of headwinds will weigh on demand. They include the expiration of the trade-in program, new austerity measures for government officials and state-owned enterprise managers, efforts to address overcapacity, and renewed property market weakness.

The government has adopted a gradual, data-dependent policy approach. Strong growth in the first half makes additional near-term stimulus unlikely. With deflationary pressures set to persist throughout 2025, the path toward reflation is likely to be gradual and bumpy.

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 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, compared with the previous year. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end.}

^{Source: Vanguard.}

Japan

BoJ adopts cautious stance amid uncertainty, capital market concerns

“We expect the BoJ will stick to its policy-normalisation cycle, as domestic inflation momentum remains well above target and wage-price dynamics are strengthening.” Grant Feng, Vanguard Senior Economist.

Tariff developments have triggered a sharp deterioration in consumer and corporate sentiment, suggesting capital expenditure momentum will fade over the coming quarters. Exports remained relatively firm in the April-May period despite U.S. tariff policy, with declines in auto exports to the U.S. partially offset by exports to Asia and frontloaded tech exports. With U.S.-Japan tariff negotiations proving challenging, we expect uncertainty about ultimate tariff levels and their economic impact to remain high.

We anticipate that the Bank of Japan (BoJ) will not make any changes at its July meeting to its current policy rate target of 0.5%, given the uncertainty surrounding U.S. tariff policy and concerns about capital market volatility. Nevertheless, we expect the BoJ will stick to its policy-normalisation cycle, as domestic inflation momentum remains well above target and wage-price dynamics are strengthening. We foresee the policy rate target ending the year at 0.75%.

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 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile fresh food prices, as of December 2025. Monetary policy is the Bank of Japan’s year-end target for the overnight rate.}

^{Source: Vanguard.}

Canada

Some positive signs amid continued trade headwinds

“While challenges remain, recent data suggest that the Canadian economy may be finding its footing.” Adam Schickling, Vanguard Senior Economist.

The Canadian economy continues to face headwinds from trade-related uncertainties, though recent indicators suggest the situation may be stabilising. Declines in wholesale trade and manufacturing resulted in GDP contracting by 0.1% in April on a monthly basis, as U.S. firms’ tariff frontrunning dissipated. But resilient domestic services consumption highlights the firmer position of non-trade-related sectors. Recent tariff developments intensify the uncertainty tax facing many Canadian businesses. But after United States-Mexico-Canada Agreement exemptions, we maintain our expectation that Canada will have one of the lowest effective tariff rates among major U.S. trading partners.

After a weak first quarter, we are seeing signs of revitalization from the Canadian consumer, as nominal wage growth remains supportive and increases in unemployment are concentrated among younger workers who account for a relatively small share of overall consumption.

The Bank of Canada (BoC) held its policy rate at 2.75% at its June meeting, but we expect it to cut the overnight rate target to 2.25% by year-end. This would provide some relief for households and businesses by bringing the policy rate to the lower end of its neutral range, where it would neither stimulate nor restrict economic activity. We maintain our 2025 GDP growth forecast of 1.25% and expect the unemployment rate to rise to 7.5% by year-end, though both are highly dependent on the outcome of U.S.-Canada trade negotiations.

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 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2025. Monetary policy is the Bank of Canada’s year-end target for the overnight rate.}

^{Source: Vanguard.}

Mexico

Mexico plays a waiting game amid trade uncertainty

“Mexico’s economy remains in a holding pattern, as trade negotiations have stalled and investment hesitates.” Adam Schickling, Vanguard Senior Economist.

Mexico’s economic momentum remains subdued in mid-2025, with growth prospects clouded by trade tensions with the U.S. While automobile exports showed surprising resilience in June, thanks to United States-Mexico-Canada Agreement exemptions and strong U.S. consumer demand, broader uncertainty around trade policy has weighed on business sentiment. Public-sector spending cuts and a second-consecutive decline in remittances, which account for nearly 4% of GDP, are also acting as headwinds. Peso appreciation has further reduced the purchasing power of remittances, adding to near-term pressures.

We continue to see long-term upside for Mexico from a U.S.-China trade realignment, given the high degree of export similarity between the two developing economies and the structural integration of U.S.-Mexico supply chains.

On the monetary policy front, the Bank of Mexico (Banxico) reaffirmed its 3% inflation target in June while cutting its policy rate by half a percentage point (to 8%), citing downside risks from trade uncertainty. With the peso strengthening and trade negotiations progressing slowly, we expect further easing, with the policy rate likely to end the year near 7.5%.

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 2025. Core inflation is the year-over-year change in the Consumer Price Index, excluding volatile food and energy prices, as of December 2025. Monetary policy is the Bank of Mexico’s year-end target for the overnight interbank rate.}

^{Source: Vanguard.}

United Kingdom

Fiscal policy set to tighten further

“With the chancellor of the exchequer’s previous fiscal headroom likely to be wiped out, expect more tax increases in the U.K. autumn budget, which will restrict growth in 2026.” Shaan Raithatha, Vanguard Senior Economist.

The U.K. chancellor of the exchequer’s previous fiscal headroom (roughly £10 billion) is likely to be wiped out ahead of the autumn budget, driven by policy developments and the Office for Budget Responsibility’s likely downgrades to near-term and trend growth. ​ An intensifying fiscal drag has long been our view and is the primary reason for our below-consensus growth forecast of 0.8% for 2026.

With the labour market and wage inflation showing signs of cooling, we expect services inflation—which has broadly tracked 5% in recent months—to soon follow suit. ​These developments, coupled with the prospect of fiscal policy being tightened further in the autumn budget and long-term inflation expectations being well anchored, should convince the Bank of England (BoE) that inflationary pressures will subside despite current stickiness.​

We continue to expect the BoE to maintain a quarterly cadence of easing. This would put the bank rate at 3.75% at the end of 2025 and at 3.25% by mid-2026.​ We also expect the BoE to set its next 12-month plan for reducing its gilt holdings at £75 billion in September 2025.​

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 2025. Core inflation is the year-over-year change in the Consumer Prices Index, excluding volatile food, energy, alcohol, and tobacco prices, as of December 2025. Monetary policy is the Bank of England’s bank rate at year-end.}

^{Source: Vanguard.}

Euro area

Germany’s fiscal stimulus bolsters growth outlook

“We are encouraged by the latest German fiscal plan, which largely eliminates short-term implementation risks. We, therefore, have shifted our balance of risks regarding the outlook for growth from ‘skewed to the downside’ to ‘broadly balanced.’” Shaan Raithatha, Vanguard Senior Economist.

We expect growth in the euro area to track around 1% in both 2025 and 2026, slightly below trend. Softening global activity, driven partly by elevated policy uncertainty and higher tariffs, is expected to weigh on final demand. The tailwinds from Germany’s recent fiscal package and greater defense spending across the European Union are more of a 2026 story. Short-term implementation risks surrounding German fiscal policy have now receded. ​

The chances of undershooting the 2% inflation target set by the European Central Bank (ECB) are rising. Both wage growth and services inflation are now falling meaningfully. And a weakening global growth outlook, coupled with a stronger euro and lower energy prices, points to further disinflation ahead. ​

Following the messaging at the ECB’s June press conference, in which the ECB president repeatedly stated that the central bank was in a “good position” at the current policy rate level of 2%, we think a pause at the July 24 meeting is now likely. We forecast just one more rate cut this cycle, likely in September, which would leave the policy rate at 1.75%, a touch below our estimate of neutral (2–2.5%). The balance of risks is skewed toward further easing.​

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 2025. 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 2025. Monetary policy is the European Central Bank’s deposit facility rate at year-end.}

^{Source: Vanguard.}

^{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.}

^{IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (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. VCMM results will vary with each use and over time.}

^{The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More importantly, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.}

^{The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard's primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, U.S. municipal bonds, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over time. Forecasts represent the distribution of geometric returns over different time horizons. Results produced by the tool will vary with each use and over time.}

^{The VCMM’s primary value is its utility in analysing potential investor portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, risk-return trade-offs, and the diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered is the most effective way to use VCMM output.}

^{The VCMM seeks to represent the uncertainty inherent in forecasting by generating a wide range of potential outcomes. The VCMM does not impose “normality” on expected return distributions but rather is influenced by the so-called fat tails and skewness of modelled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential investment outcomes. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.}

^{Indexes for VCMM simulations}

^{The long-term returns of our hypothetical portfolios are based on data for the appropriate market indexes as of April 30, 2025. We chose these benchmarks to provide the most complete history possible, and we apportioned the global allocations to align with Vanguard’s guidance in constructing diversified portfolios.}

^{Asset classes and their representative forecast indexes are as follows:}

^{Australia (Australian dollar)}

^Equities:

• ^{Australian equities: MSCI Australia Total Return Index}
• ^{Global ex-Australia equities (unhedged): MSCI All Country World ex Australia Total Return Index}
• ^{US equities (unhedged): MSCI US Broad Market Index}
• ^{Fixed income}
• ^{Australian aggregate bonds: Bloomberg Australian Aggregate Index}
• ^{Global ex-Australia aggregate bonds (hedged): Bloomberg Global Aggregate ex AUD Index AUD Hedged}

^{This article contains certain 'forward looking' statements. Forward looking statements, opinions and estimates provided in this article are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Forward-looking statements including projections, indications or guidance on future earnings or financial position and estimates are provided as a general guide only and should not be relied upon as an indication or guarantee of future performance. There can be no assurance that actual outcomes will not differ materially from these statements. To the full extent permitted by law, Vanguard Investments Australia Ltd (ABN 72 072 881 086 AFSL 227263) and its directors, officers, employees, advisers, agents and intermediaries disclaim any obligation or undertaking to release any updates or revisions to the information to reflect any change in expectations or assumptions.}