Investment and economic outlook, October 2025

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Australia

Modest disinflation, tight labour market warrant caution

“We expect the Reserve Bank of Australia to maintain a cautious monetary policy stance, with any future easing likely to proceed at a measured pace.” Grant Feng, Vanguard Senior Economist

The economy is bouncing back strongly, the labour market remains steady, and price pressures are proving somewhat stubborn. Meanwhile, persistent labour market tightness and a recovery in domestic demand recovery suggest that the pace of further disinflation will likely be slow. Although tariffs are elevated, the peak of uncertainty is largely behind us, and the global economy remains resilient.

Accordingly, we expect the Reserve Bank of Australia (RBA) to maintain a cautious monetary policy stance, with any future easing likely to proceed at a measured pace.

Our baseline view is that the RBA will deliver one quarter-point cut to its cash rate target in the fourth quarter, to a year-end target of 3.35%. However, an upside surprise from the August Consumer Price Index (CPI) report, alongside the firming economic recovery, raises the risk of a rate pause. The third-quarter CPI release, scheduled for October 29, is likely to be influential.

Vanguard Capital Markets Model® forecasts

Our 10-year annualised nominal return and volatility forecasts are based on the June 30, 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 June 30, 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.}

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

AI-related business investment provides a GDP backstop

“Recent data have pointed to stronger economic activity, but rapidly evolving trends in immigration and AI-driven productivity are reshaping labour and output dynamics, making it increasingly difficult to distinguish short-term cyclical fluctuations from longer-term structural shifts.” Josh Hirt, Vanguard Senior Economist

While our base case continues to anticipate a modest growth environment, recent data call attention to emerging upside risks worth monitoring. Chief among these is a surge in business investment, particularly in AI-related capital expenditures (capex). This wave of tech-driven capex has provided a meaningful backstop to 2025 GDP, with early data suggesting that growth otherwise would have been significantly weaker. If this momentum continues, supported by favourable financial conditions, only moderate tariff pass-through, and fiscal support, more positive growth scenarios could materialise.

However, downside risks remain, particularly in the labour market, where job creation has been subdued. More importantly, the supply side of the economy is evolving rapidly in ways that add uncertainty. Immigration trends and the anticipated productivity gains from AI are reshaping labour and output dynamics rapidly, making it increasingly difficult to distinguish cyclical fluctuations from structural shifts, and introducing uncertainty around the sustainability of recent growth surprises. This evolving landscape warrants close attention, especially as policy and investment responses adapt to these new realities.

We continue to monitor the U.S. government shutdown, although historically there has been no clear relationship between shutdowns and market returns. Economic effects have largely depended on the duration of shutdowns.

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.} 

Canada

Balancing global pressures with domestic resilience

“Despite persistent global headwinds, Canada’s trade resilience and policy flexibility provide a foundation for cautious optimism.” Adam Schickling, Vanguard Senior Economist

Canada’s economy continues to face meaningful challenges, and while recent data suggest a degree of resilience, the overall outlook remains subdued. Following a 1.6% annualised GDP contraction in the second quarter, growth is expected to recover only modestly in the second half of the year. Trade tensions with the U.S., particularly around steel and automobiles, have weighed on exports and business investment, and the outlook remains highly sensitive to the trajectory of negotiations. 

Our 2025 GDP forecast stands at 1.25%, modestly above consensus, reflecting Canada’s relatively favourable trade position with the U.S. Canada benefits from United States-Mexico-Canada Agreement exemptions, resulting in one of the world’s lowest effective tariff rates at approximately 6%. 

Domestic demand has shown pockets of resilience. Retail sales rebounded in August following a July slump, with households benefiting from lower interest rates as the Bank of Canada (BoC) has cut its policy rate by 2.5 percentage points since April 2024. Labour market slack remains a risk as businesses are cautious about hiring new workers in the face of elevated macroeconomic uncertainty. 

But the September employment report, which showed the addition of about 60,000 jobs, was encouraging. A considerable increase in manufacturing employment suggests that Canada’s relative trade advantage is providing a level of support for the challenged sector. This development and domestic demand resilience have led us to lower our year-end unemployment rate forecast from 7.5% to 7.3%. The unemployment rate was unchanged in September at 7.1%. 

The BoC lowered its policy rate by 25 basis points to 2.5% in mid-September, citing a weaker economic backdrop and diminished inflationary pressures. (A basis point is one-hundredth of a percentage point.) This decision reflects a balancing of risks amid slowing global growth and the removal of most retaliatory tariffs on U.S. imports. September’s labour market report likely gives the bank some pause related to further accommodation, but we ultimately expect one more 25-basis-point cut before year-end.

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 balances resilience and risk amid global uncertainty

“Nearshoring momentum and advantages of the United States-Mexico-Canada Agreement keep Mexico’s long-term outlook constructive, even as short-term risks from tariffs and weak investment weigh on growth.” Adam Schickling, Vanguard Senior Economist

Mexico’s economy has demonstrated resilience in 2025 despite persistent trade uncertainty with the United States. After an unimpressive first quarter, real GDP growth accelerated 0.6% quarter-over-quarter in the second quarter, supported by gains in manufacturing and services. External trade remains resilient, but heightened economic uncertainty and sluggish private investment continue to weigh on domestic demand recovery. 

Automotive exports have fallen modestly, due to tariffs and softer U.S. consumer demand, but overall exports still grew by 4.3% in the first half of 2025. Mexico retains a competitive edge under the United States-Mexico-Canada Agreement (USMCA), with the vast majority of exports to the U.S. being duty-free. That keeps Mexico’s effective tariff rate near 8%, among the lowest globally. However, uncertainty surrounding the 2026 USMCA review and potential tariff escalation continues to weigh on business sentiment and fixed investment.

Longer-term prospects remain constructive. Nearshoring trends reinforce Mexico’s role as a key North American manufacturing hub. Competitive labour costs, geographic proximity, and deep structural integration with U.S. industry position Mexico favourably for the future. Infrastructure improvements, such as the new Puerto del Norte port, further support this optimism. 

On the monetary front, the Bank of Mexico cut its policy rate by a quarter percentage point to 7.5% in September, emphasising significant downside risks from a slowing global economy and confidence that headline inflation would gradually converge to target in 2026. We expect one more quarter-point cut this year before a pause amid sticky core inflation and global economic downside risks abating.

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

Tighter fiscal policy to weigh on growth in 2026

“Tighter fiscal policy will slow growth in 2026. We estimate the chancellor of the exchequer will need to find £20 billion to £30 billion of savings in the next budget to meet fiscal rules to which she’s committed.” Shaan Raithatha, Vanguard Senior Economist

U.K. growth over the last year has been healthy and close to its potential. Looking through the tariff and national insurance tax-hike frontrunning in the first quarter, growth in the first half of 2025 was quite balanced, with consumer spending, government spending, and business investment all making meaningful contributions.

We are constructive on the outlook for the second half of the year. Solid investment in a highly uncertain trade environment in the first half was an encouraging signal for the second half. The government’s commitment to raise day-to-day spending will continue to be a positive impulse. We expect 2025 growth of 1.3%.

But growth in 2026 will be more muted. This is primarily because the chancellor of the exchequer will be forced to raise taxes in the autumn budget. We estimate the chancellor will need £20 billion to £30 billion of savings to meet fiscal rules to which she’s committed. We forecast growth of just 0.8% in 2026.

We no longer expect the Bank of England (BoE) to ease monetary policy again this year. Recent payroll data suggest the labour market is softening rather than collapsing. Broader economic activity shows no signs of material weakness yet. We push our expectation for the next BoE cut into 2026 and expect the bank rate to 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 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

Window for an additional rate cut appears to have closed

“A lack of softening in recent activity and inflation data closes the window for an additional European Central Bank ’insurance cut.’ We are dropping what would have been the last cut from our forecast and now foresee the policy rate staying at 2% until the end of 2026.” Shaan Raithatha, Vanguard Senior Economist

The euro area outlook is shaped by two opposing dynamics. The first is the drag on the economy from higher U.S. tariffs, with the effective rate likely to have increased by around 15 percentage points by the end of 2025. The second is the tailwind from looser fiscal policy, led by Germany’s infrastructure package and greater European Union-wide defense spending.

The inflation outlook remains benign. The European Central Bank (ECB) has achieved a “soft landing.” Inflation and inflation expectations are both tracking close to 2%, and wage growth has moderated materially.

A lack of softening in recent activity and inflation data suggests the window for an additional ECB “insurance cut” has closed. We are dropping what would have been the last cut from our forecast and now foresee the policy rate staying at 2% until the end of 2026. However, risks skew toward an inflation undershoot and additional monetary easing next year.

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.} 

Japan

Central bank’s rate-hike path remains intact

“Trade uncertainty that has subsided and persistent inflationary momentum put the Bank of Japan in position to resume policy rate hikes.” Grant Feng, Vanguard Senior Economist

Japan’s economy is still expanding, supported by stable domestic demand and better-than-expected exports. Large manufacturers are reporting modestly firmer sentiment, and the activity of nonmanufacturers remains high. Meanwhile, investment in software and digitalisation continues to offset labour shortages. For smaller firms, however, pressure on margins is keeping sentiment fragile.

While the impact of earlier shocks, including elevated import prices and food costs, is expected to fade, underlying inflationary pressures remain intact. These are driven by structural labour shortages, which are exerting upward pressure on wages and reinforcing a virtuous cycle of wage growth and price increases compared with recent decades. (Japan struggled with economic stagnation and deflation for many years in the 1990s and 2000s.)

With the peak of trade uncertainty likely behind us and the economy proving resilient, we expect the Bank of Japan (BoJ) to proceed with policy normalisation, gradually moving interest rates higher as economic conditions evolve in line with its forecasts.

The BoJ may need to monitor foreign exchange developments closely due to capital market stability concerns. While the current policy stance remains accommodative, the bank’s forward guidance implies a data-dependent approach, with the potential for future adjustments should inflation expectations and wage dynamics strengthen further.

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.} 

China

Eyes are on a new five-year plan as growth moderates

“China’s full-year growth target appears largely on track, with resilient third-quarter real GDP. However, an imbalance between supply and demand is growing. Although a third-quarter slowdown in exports was less severe than expected, a broader downtrend is likely to continue amid rising global trade barriers.” Grant Feng, Vanguard Senior Economist

Better-than-expected third-quarter GDP growth of 4.8% year over year kept China’s 5% annual growth target within reach. Robust export activity continued to support industrial production despite mounting global trade uncertainty. However, domestic challenges persist, and the gap between supply-side strength and weak domestic demand has widened. The GDP deflator, an output-related measure of price changes, was negative for the 10th time in 11 quarters, extending China’s historic deflationary stretch. Although a recent stock market rally has boosted financial sector output through increased trading activity, its broader expansionary impact on the real economy may be limited.

On the external front, renewed trade tensions with the U.S. could dampen market sentiment somewhat. However, the tensions have an aspect of strategic positioning ahead of a potential meeting of the nation’s leaders at the forthcoming Asia-Pacific Economic Cooperation summit.

We believe broad-based stimulus is unlikely in the near term. However, moderating growth, and especially weakness in investment, appears to have alerted policymakers to the need for some fiscal support, which should aid domestic demand into 2026, albeit modestly. We expect only a mild policy rate reduction of 10 basis points for the rest of the year to facilitate fiscal expansion. The forthcoming release of the 15th five-year plan will inform China’s structural policy agenda, offering high-level strategic guidance.

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, as of December 2025. Monetary policy is the People’s Bank of China’s seven-day reverse repo rate at year-end.}

^{Source: Vanguard.} 

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

^{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.}

By Vanguard
29 October 2025
vanguard.com.au/