Vanguard economic update: Outlook mixed as energy prices stay high

While growth remains steady in some regions, higher energy prices and ongoing tensions in the Middle East are weighing on activity and pushing inflation¹ higher, leading central banks to take a cautious approach to interest rates.

Below, we set out our current thinking on how these developments are affecting the world’s major economies.

United States

The US economy remains in a relatively strong position, supported by continued strength in business investment and resilient consumer demand. However, energy prices remain high and we would need to see these fall for the recent economic trends to continue.

Key points

• Our current analysis suggests US economic growth of 2.3% in 2026.

• The labour market remains in good shape, although it is moving to a slower growth phase.

• Inflation has remained elevated because energy prices remain high, driven by conflict in the Middle East and trade tariffs.

• Core inflation (which excludes food and energy prices) is expected to end the year at 2.8%.

• The Federal Reserve (the US central bank) is likely to remain cautious due to higher inflation, but we still expect one interest rate cut in 2026.

United Kingdom

The UK economy faces a more challenging backdrop because of the Middle East conflict, which has resulted in higher energy prices and tighter financial conditions.

Key points

• We expect UK economic growth of 1.1% in 2026, up from our previous forecast of 0.6%. We still think growth will soften over the rest of the year as higher energy costs and tighter financial conditions weigh on activity.

• Higher energy prices are quickly feeding into consumer prices, with inflation rising from 3.0% in February to 3.3% in March. As a result, we have increased our 2026 inflation forecast by 0.8 percentage points to 3.6%.

• We expect the Bank of England to raise interest rates by 0.5 percentage points this year, taking rates to 4.25% by the end of 2026.

Euro area

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

Key points

• We expect economic growth of 0.8% in 2026, down 0.4 percentage points from our pre-conflict forecast.

• Higher energy prices are feeding into consumer prices quickly and supply chains are being disrupted. However, the impact is likely to be weaker than with the 2022 Ukraine war because the euro area came into this latest shock from a position of relative strength.

• Core inflation is forecast to end the year at 2.2%.

• The European Central Bank is expected to raise interest rates by around 0.5 percentage points this year, with the first increase coming as early as its June meeting. We expect two cuts in 2027 once the energy shock fades.

Japan

Japan’s economy is being weighed down by higher energy costs, which are affecting both businesses and households. However, the impact appears to be manageable, reflecting Japan’s ample oil reserves, improved energy efficiency and structural resilience.

Key points

• We expect economic growth of 0.8% in 2026.

• Annual wage negotiations could deliver average pay increases above 5%, giving the Bank of Japan confidence that inflation will be sustained rather than temporary.

• We continue to expect two further interest rate hikes this year, which would take rates to 1.25% by the end of 2026.

• The timing of these rate hikes will depend on inflation, wage and activity data, as well as the persistence of the energy shock.

China

China’s economy was stronger than expected in the first quarter, supported by resilient exports and government support measures. However, growth remains uneven. Industrial production beat forecasts by a wide margin in the first quarter, reflecting resilience in manufacturing and artificial intelligence-linked sectors. In contrast, consumer demand disappointed as retail sales softened.

Key points

• So far, the Middle East conflict has had a limited impact on economic growth, but while China is better cushioned from the oil shock, it is not immune and higher energy prices still pose risks.

• The stronger-than-expected start to 2026 reduces the urgency for further near term economic stimulus.

• We therefore expect the People’s Bank of China to keep interest rates unchanged this year, focusing instead on targeted support for specific sectors.

All facts and figures from Vanguard analysis, May 2026.
 

¹ Inflation is the rise in prices for goods and services over time, meaning your money buys less than it used to.

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