Vanguard’s mid-year economic outlook: When AI meets oil

Two forces are shaping today’s economic and investment landscape: the rise of artificial intelligence (AI) and the oil shock caused by the Middle East conflict.

AI is driving growth and innovation, whereas the oil shock is weighing on global growth and adding to inflationary pressures. These two forces are affecting regions differently, creating a wider gap in economic performance.    

Here, our economists set out what’s driving these trends and how they are shaping the economic outlook.

AI: a powerful driver of growth, but not without bumps

In the US, AI is already contributing to stronger company profits and helping to lift economic growth.

Investment is accelerating quickly: AI-related capital expenditure is currently exceeding its elevated late-2025 levels and tracking above our predictions for 2026. This wave of investment resembles periods of large-scale capital expansion in the past, such as the railroad buildout in the 19th century and the late-1990s technology boom.

The transition from investment to broad productivity gains will take a few years to unfold. Over time, we expect AI to materially boost worker productivity, helping to lower both production and labour costs. This could help bring down inflation¹ over time towards the Federal Reserve’s (the US central bank) 2% target.

The impact of AI isn’t limited to the US. Parts of Asia, including China, are already benefitting through stronger exports linked to AI and the shift to cleaner technologies.

Oil: a drag on growth and a source of inflation

At the same time, higher oil prices – stemming from the Middle East conflict – are pushing up costs and weighing on global growth. This is also adding to inflation, creating a more challenging backdrop for households and central bank policymakers.

The euro area is particularly exposed to oil prices. Higher energy costs have weighed on growth and fed into consumer prices quickly. However, the wider impact on inflation is likely to be limited. That’s partly because the euro area came into this latest shock from a position of relative strength, with inflation close to the European Central Bank’s (ECB) 2% target.

Europe is also lagging the US in AI investment, which means it has fewer growth drivers to offset higher energy costs.

While higher energy prices are lifting headline inflation globally, the impact on core inflation (which excludes energy and food prices) remains limited – helped by stable long-term expectations and the likelihood that the shock will fade over time.

These two forces are pulling in opposite directions – one powering the economy forward, the other holding it back. That tension is likely to persist, making diversification and a long-term approach as important as ever.

While global trends set the backdrop, the outlook varies by region. Here, our economists take a closer look at what’s happening across key markets – and what it could mean for investors.

United States

The US economy continues to show resilience, helped by strong business investment (especially in AI) and steady consumer spending. But inflation remains higher than expected, which is likely to keep interest rates elevated for longer.

Key points

• Our current analysis suggests US economic growth of 2.3% in 2026, supported by AI investment and consumer demand.
• Inflation is still above target, driven by services and higher energy costs.
• The jobs market remains in good shape, though hiring could slow in the near term.
• Interest rates are likely to stay higher for longer, with no cuts expected in 2026 or 2027.

United Kingdom

The UK economy started the year on a strong footing, but higher energy prices and tighter financial conditions are expected to slow things down. Inflation remains a key concern, making the outlook more uncertain.

Key points

• We recently increased our forecast for UK economic growth from 0.6% to 1.1% for 2026, following a strong first quarter. However, we still expect it to slow in the second half of this year.
• Higher energy costs are pushing up inflation.
• The Bank of England may still raise rates, but less aggressively than previously expected partly due to a weaker labour market.

Euro area

Growth in the euro area has weakened, with higher energy prices and global uncertainty weighing on activity. While inflation is rising in the short term, it’s expected to settle back down over time.

Key points

• We have lowered our economic growth forecast from 1.2% to 0.8% for 2026, due to higher energy costs and trade disruption.
• Businesses are facing higher input costs and supply chain challenges, which are adding to inflationary pressures.
• We expect two interest rate hikes this year, but we think there will be two cuts in 2027 as the impact of the Middle East conflict fades.

Japan

Japan has seen stronger‑than‑expected growth, helped by exports and household spending. However, higher energy prices could put pressure on both businesses and consumers in the months ahead.

Key points

• We expect economic growth of 0.8% in 2026, as AI and energy subsidies partly offset higher energy prices.
• After slowing sharply in April, inflation is expected to rise again as businesses are becoming more willing to pass on higher costs to consumers. We expect core inflation to end the year at 2.1%.
• We continue to expect two further rate hikes by the end of 2026, which would take rates to 1.25%.

China

China’s economy continues to grow at a relatively strong pace, supported by exports and AI. However, weaker consumer demand and a struggling property sector mean growth is uneven.

Key points

• We expect economic growth of 4.7% in 2026, supported by exports and investment in areas like AI.
• Consumer demand has weakened and the property sector is still a drag on growth.
• While higher energy prices and supply chain pressures are pushing up producer and input prices, these haven’t been passed on to consumers, which means inflation remains relatively low.
• The People’s Bank of China is likely to stay cautious and keep rates on hold this year, with targeted support for certain sectors rather than a broad-based rate cut.

All facts and figures from Vanguard analysis, June 2026.

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