Investment and economic outlook, May 2025

Tariff reprieves, trade deals brighten the economic horizon

Australia

Amid weaker global growth, expect a dovish central bank.

“Given the combination of weaker global growth and heightened uncertainty, we expect the Reserve Bank of Australia to adopt a dovish stance.” Grant Feng, Vanguard Senior Economist.

For Australia, the direct impact of U.S. tariffs should be limited. The country exports a relatively small volume of goods to the U.S., and the reciprocal U.S. tariff rate on Australian goods was set at 10%, the lowest among affected countries, in early April. However, the indirect effects are likely to be more significant, including slower economic growth in China and a negative impact on domestic consumption and business investment confidence. Overall, we expect the Australian economy to grow 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 it is likely to be toward the upper half of that range. A tight labour market will continue to exert upward pressure on unit labour costs, prolonging the disinflation process. Additionally, supply-side weakness, stemming from lacklustre productivity growth, will remain a hindrance to faster disinflation in 2025.

Given the combination of weaker global growth and heightened uncertainty, we expect the RBA to adopt a dovish stance. The RBA cut its policy rate by 0.25 percentage points to 3.85% on May 20. We foresee two further quarter-point cuts this year.

Australia economic forecasts

Asset class	Return range	Median volatility
Australian equities	5.6% - 7.6%	20.1%
Global ex-Australia equities (unhedged)	5.3% - 7.3%	16.4%
US equities (unhedged)	4.6% - 6.6%	17.4%
Australian aggregate bonds	3.5% - 4.5%	6.3%
Global ex-Australia aggregate bonds (hedged)	3.9% - 4.9%	5.3%

^{Notes: Values are approximate. 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 RBA’s year-end cash rate target.}

^{Source: Vanguard.}

Capital Markets Model® forecasts

Australia (Australian dollar)

	GDP growth	Unemployment rate	Trimmed mean inflation	Monetary policy
Year-end outlook	2%	4.2%	2.5%	3.35%

^{Source: Vanguard}

United States

Tariff reprieve strengthens our 2025 outlook.

“The recent tariff developments, if sustained, would mitigate the challenges to the Federal Reserve’s dual mandate of ensuring price stability and supporting maximum sustainable employment.” Josh Hirt, Vanguard Senior Economist.

Positive trade developments with China have lowered our assessment of where the United States’ effective tariff rate on its trading partners will stand at year-end, to a range just above 10%. Although elevated compared with last year, it is significantly lower than our assessment of around 20% immediately after the broad U.S. tariff announcement on April 2.

A trade truce on May 12 with China specifically, which included the lowering of U.S. tariffs on Chinese goods to 30% for 90 days, informs our revised outlooks for the U.S. economy. We now expect GDP growth of around 1.5% this year, or double our previous estimate. Although we anticipate the unemployment rate increasing from current levels, we no longer see it rising as high as 5%.

We expect the pace of inflation to increase too, though not to the levels we had envisioned pre-truce. We anticipate that goods prices will spike into the U.S. summer as tariff-induced price increases take effect. Leading indicators suggest some modest relief for shelter inflation later in the year, though potential developments with lumber tariffs present an upside risk.

The recent tariff developments should mitigate the severity of the challenges to the Federal Reserve’s dual mandate of ensuring price stability and supporting maximum sustainable employment. We continue to expect two quarter-point Fed rate cuts in the second half of the year. The Fed will have room to be patient with rate cuts if the labour market remains resilient.

United States economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	1.5%	4.7%	3%	4%

^{Notes: Values are approximate. 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

Trade uncertainty likely to weigh on investment.

“Significant U.S. tariffs are likely to weigh on Canadian business investment, consumer spending, and the labour market.” Adam Schickling, Vanguard Senior Economist.

The Canadian economy has been challenged by trade-related uncertainties and softening demand for services. Despite recent interest rate cuts, significant tariffs on Canada’s automobile sector and broader tariff measures from the U.S. are likely to weigh on Canadian business investment, consumer spending, and the labour market. We expect the Canadian economy to grow around 1.25% in 2025 and the unemployment rate to rise to about 7% by year-end, but both forecasts are sensitive to U.S.-Canada trade developments.

The Bank of Canada (BoC) opted to hold its policy overnight rate at 2.75% at its April 16 meeting, a pause in what had been seven consecutive rate cuts. Policymakers emphasised the need for caution amid substantial U.S.-Canada trade uncertainty and concerns about the inflationary implications of retaliatory tariffs on U.S. imports. Ultimately, we expect the economic impacts from tariffs and trade uncertainty to outweigh any inflationary risks, prompting the BoC to cut the overnight rate by half a percentage point by year-end, to 2.25%.

Canada economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	1.25%	7%	2.5%	2.25%

^{Notes: Values are approximate. 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 BoC’s year-end target for the overnight rate.}

^{Source: Vanguard.}

Mexico

Challenges, opportunities for Mexico amid tariffs.

“The potential for U.S.-Mexico trade negotiations to occur relatively soon could mitigate some possible negative tariff impacts.” Adam Schickling, Vanguard Senior Economist.

We recently revised our 2025 GDP growth forecast for Mexico to below 1% due to headwinds from trade developments and the uncertainty surrounding trade policy, which are affecting business investment and manufacturing employment. The Bank of Mexico (Banxico) cut the overnight interbank rate by 50 basis points to 8.5% on May 15, citing increased global risks amid escalating trade tensions and stable inflation. We expect the rate to end 2025 from 8% to 8.25%.

The recent announcement of U.S. tariffs on the Mexican automobile sector is particularly significant, given that sector’s importance to the Mexican economy. The automotive industry accounts for about 4% of Mexico’s GDP and employs approximately 1 million workers. Despite these challenges, the potential for U.S.-Mexico trade negotiations to occur relatively soon could mitigate some of the adverse effects.

Additionally, Mexico may benefit from high U.S. tariffs on Chinese imports. This situation could create upside potential for growth as Mexico positions itself as an alternative manufacturing hub, leveraging its strategic location and skilled workforce. The evolving trade landscape offers both challenges and opportunities for Mexico’s economy in the coming year.

Mexico economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	<1%	3.2% - 3.6%	3.5%	8% - 8.25%

^{Notes: Values are approximate. 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

Conditions are favorable for progress on inflation.

“Expectations of further fiscal tightening and long-term inflation expectations that remain well anchored are likely to give the Bank of England conviction that inflationary pressures will subside.” Shaan Raithatha, Vanguard Senior Economist.

An improved global outlook and greater-than-expected growth in the first quarter have led us to raise our forecast for full-year GDP growth to just above 1% from around 0.5%. Progress in U.S.-U.K. and U.S.-China trade relations underpin the more optimistic global view. First-quarter growth of 0.7% was driven by net exports and business investment, suggesting frontloading ahead of U.S. tariffs. We expect materially softer growth in the second quarter as an aftereffect of the frontloading and amid continued trade uncertainty.

Core inflation remains elevated, with little progress made on services inflation or wage growth in recent months. That said, employment growth has softened materially, partly due to the government’s decision in October 2024 to raise taxes for employers. Surveys point to some labour-market deterioration ahead. Expectations of further fiscal tightening and long-term inflation expectations that remain well anchored are likely to give the Bank of England (BoE) conviction that inflationary pressures will subside.

We continue to expect the BoE to cut the bank rate by 25 basis points each in the third and fourth quarters. That would leave the policy rate at 3.75% at year-end, a touch above our assessment of the neutral rate, or the policy rate that would neither stimulate nor inhibit growth.

United Kingdom economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	1.1%	4.8%	2.9%	3.75%

^{Notes: Values are approximate. 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 energy, food, 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

Global trade developments brighten prospects for Europe.

“The improved growth prospects and reduced risk of Chinese exports being rerouted to Europe decrease the risk of a material undershoot of the 2% inflation target.” Shaan Raithatha, Vanguard Senior Economist.

Global trade developments have been positive for the euro area growth outlook. A U.S.-China tariff truce boosts global growth prospects and eases financial conditions, while initial U.S. agreements with the U.K. and China raise hopes for similar U.S.-euro area progress. We have increased our 2025 euro area growth outlook to just above 1%.

The improved growth prospects and reduced risk of Chinese exports being rerouted to Europe decrease the risk of a material undershoot of the 2% inflation target set by the European Central Bank (ECB). Domestic inflationary pressures remain subdued, with target-consistent progress being made on the most stubborn parts of services inflation.

Modest upgrades to our growth and inflation forecasts don’t change our view on the ECB policy rate. We continue to foresee two more quarter-point cuts this year, which would leave the deposit facility rate at 1.75% at year-end from its current 2.25%. That would be slightly below our estimate of the euro area’s neutral rate, or the interest rate level that would neither stimulate nor inhibit an economy.

Euro area economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	1.1%	6.3%	2.1%	1.75%

^{Notes: Values are approximate. 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.}

China

Progress on trade improves prospects for China’s growth.

“With progress on trade negotiations, we expect policymakers to adopt a more reactive stance to further stimulus. Such an approach is also reflected in our monetary policy view.” Grant Feng, Vanguard Senior Economist.

Positive U.S.-China trade developments make us more optimistic about China’s growth prospects. After the U.S. and China agreed on May 12 to lower tariffs on each other’s goods for 90 days, we have increased our forecast for China’s 2025 economic growth to 4.6%. However, risks to the downside remain significant, given the disruption to China’s exports that has already occurred and an effective U.S. tariff rate on China that remains well above the rate before the April 2 U.S. tariff announcements.

Although a renewal of heightened tensions can’t be ruled out, progress on trade negotiations to date reduces the urgency for additional policy support. We expect policymakers to adopt a more reactive stance to further stimulus. Such an approach is also reflected in our monetary policy view. We foresee China’s policy rate—the seven-day reverse repo rate—ending 2025 at 1.3%, higher than our previous forecast of 1.2%. The People’s Bank of China announced a 10-basis-point cut to its policy rate, to 1.4%, on May 7. (A basis point is one-hundredth of a percentage point.)

We have lowered our forecast for headline inflation at year-end to just above zero as progress in trade talks eases pressure on prices of imported food, most notably U.S. soybeans. Meanwhile, uncertainty continues to weigh on energy prices. Our outlook for core inflation remains unchanged at 0.5%.

China economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	4.6%	5%	0.5%	1.3%

^{Notes: Values are approximate. 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.}

Japan

Tariff challenges give BoJ a reason to be cautious.

“The Bank of Japan will continue to assess the downside risk to growth and inflation, given recent developments in U.S. tariff policy and their potential impact.” Grant Feng, Vanguard Senior Economist.

The persistence of tariff challenges is likely to have a significant impact on Japanese exporters. While the direct effects of tariffs may be limited, the uncertainty they create can dampen business confidence and investment, leading to a more cautious approach by the Bank of Japan (BoJ) as it considers rate hikes.

Still, a virtuous cycle of wages and inflation is likely to support the economy. Nationwide wage negotiations for unionised workers are tracking above last year’s increases, which were the largest in 33 years. Prices continue to rise, and a structural labour shortage has buoyed capital expenditures as firms seek to enhance productivity. The cycle is likely to strengthen, keeping core inflation above the BoJ’s 2% target throughout 2025.

However, the uncertainty surrounding U.S. tariff policy poses a notable hurdle for the BoJ in assessing its conviction about growth and inflation sentiment in the near term. As a result, we expect the BoJ to pause any rate hikes until the tariff situation stabilises. That said, the BoJ is likely to stick to its policy-normalisation cycle, given that domestic inflation momentum remains above target and wage-price dynamics are strengthening. The BoJ left its policy rate unchanged at 0.5% on May 1.

Japan economic forecasts

	GDP growth	Unemployment rate	Core inflation	Monetary policy
Year-end outlook	0.7%	2.4%	2.4%	1%

^{Notes: Values are approximate. 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 BoJ’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.}

^{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.}

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^{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.}

By Vanguard
28 May 2025
vanguard.com.au