European bond yields fell, and French spreads remained high. Ibex rose 4%, euro weakened. Brent crude dropped 2.46% due to rising US stockpiles and China’s PMI slowdown.

European bond yields experienced a decline over the week, while French bond spreads remained elevated due to persistent political and budgetary uncertainties. The stock market showed positive momentum, with the Ibex leading the gains, rising by 4%. The Ibex 35 closed January with a 6.67% increase. The euro weakened against the dollar, finishing the week at 1.0359. Brent crude oil prices dropped by 2.46%, following a 3.46 million-barrel increase in US stockpiles, raising concerns about oversupply and sluggish demand. Additionally, China's PMI fell to 49.1, signalling a slowdown in industrial activity and further exerting downward pressure on global oil prices.

The ECB cut rates to 2.75% amid stagnating Eurozone growth, with inflation easing in Germany. Further cuts are expected, while economic challenges persist, especially in Germany and France.

The ECB reduced interest rates by 25 basis points to 2.75%, signalling its continued efforts to address inflation and economic challenges. While inflationary pressures persist, the ECB remains focused on boosting the sluggish Eurozone economy, with further rate cuts expected, including a likely reduction in March. Eurozone GDP stagnated, with Southern European nations showing modest growth, while Germany and France faced economic contraction. Germany's GDP shrank by 0.2% in 2024, driven by manufacturing struggles, underinvestment, and political shifts that have sidelined economic reforms. Inflation in Germany dropped to 2.3% in January, but rising unemployment points to a weakened labour market, limiting recovery prospects. The ECB is expected to continue its rate-cutting cycle to support economic growth, though geopolitical risks like potential tariffs from the U.S. could reignite inflationary pressures. Despite these challenges, the European Commission is focusing on increasing competitiveness to drive long-term recovery.

The ECB cut interest rates by 25 basis points to 2.75%, signalling continued monetary easing, with further cuts expected, as inflation pressures and economic challenges persist.

The European Central Bank (ECB) has reduced its policy interest rates by 25 basis points to 2.75%, signalling its ongoing efforts to achieve monetary neutrality. Despite persistent inflationary pressures, the ECB remains focused on addressing the subdued state of the Eurozone economy, with a strong conviction that inflation will eventually return to its 2% target. The decision, in line with the ECB's December guidance, reflects the central bank's cautious approach, maintaining a meeting-by-meeting evaluation. While the deposit rate remains restrictive for the current economic conditions, the ECB is expected to continue its rate-cutting cycle, with another 25 basis point reduction anticipated in March, potentially bringing the deposit rate closer to the neutral range of around 2.50%.

In her press conference, ECB President Christine Lagarde reiterated that despite the rate cut, monetary policy remains restrictive, acknowledging the Eurozone's ongoing economic weaknesses. She highlighted that the ECB's macroeconomic outlook had not significantly changed since December, with the bank continuing to expect inflationary pressures to subside over the course of the year, though the Eurozone faces near-term economic challenges. Lagarde emphasized the importance of strong export performance as a key driver of recovery but noted the associated risks due to ongoing tariff tensions. While inflation has accelerated in the short term, Lagarde expressed confidence that it will settle back to target later in the year. The ECB's commitment to staying ahead of the curve in addressing these challenges suggests further policy adjustments may be necessary, with the neutral interest rate likely to be reached in the coming months.

We expect more rate cuts throughout the year as economic weakness persists, particularly in Germany and France

Eurozone GDP stagnated, with Southern Europe performing better than larger economies. Consumer recovery is slow, while investment and exports remain weak amid economic uncertainty and high interest rates.

Eurozone GDP growth stagnated at 0% by the end of last year, following a modest recovery from the energy and inflation shocks. While Southern European countries, such as Spain (0.8% QoQ) and Portugal (1.5% QoQ), have maintained solid growth, larger economies like France (-0.1% QoQ), Germany (-0.2% QoQ), and Italy (0% QoQ) have experienced either contraction or stagnation. Consumer recovery remains slow, with purchasing power not translating into strong consumption, and investment continues to be hindered by high inventories, economic uncertainty, and elevated interest rates. The export sector also struggles due to weak external demand. In response, policymakers are intensifying efforts: the ECB is expected to further reduce interest rates by 0.25 percentage points, targeting a neutral deposit rate of 2%, potentially lowering it to 1.75%. Additionally, the European Commission, under President Ursula von der Leyen, has introduced a Competitiveness Compass aimed at enhancing productivity and competitiveness, though its success will depend on effective implementation. Despite a subdued immediate economic outlook, there are expectations that domestic demand will drive modest growth over the course of this year.

We expect the ECB to cut rates more aggressively than the Fed, which could drive recovery and show positive signs in the second half of the year.

Germany's economy contracted by 0.2% in 2024, reflecting structural challenges, manufacturing struggles, and underinvestment. Political shifts away from economic issues complicate recovery and reforms.

The German economy has once again made headlines for the wrong reasons, as it officially ended 2024 in contraction, shrinking by 0.2% QoQ and YoY—marking the third consecutive year it closed with a negative quarter. While detailed GDP data will be released next month, preliminary figures suggest that exports were the primary driver of the downturn. This prolonged economic stagnation reflects the culmination of cyclical and structural headwinds, with 2024 serving as the tipping point where policymakers recognized that Germany's traditional macroeconomic model—reliant on cheap energy and expansive export markets—was no longer viable. Years of underinvestment, declining competitiveness, and China's evolution from a key export destination to a formidable industrial rival have further exacerbated these challenges. Unlike the early 2000s, when high unemployment and rigid labour markets were central concerns, today’s economic issues are broader and more complex, compounded by geopolitical tensions, trade protectionism, and regional conflicts.

Industrial production remains significantly below pre-pandemic levels, with capacity utilization nearing financial crisis-era lows, highlighting the struggles of Germany’s manufacturing sector and its spillover effects on the broader economy. Looking ahead, a meaningful recovery remains elusive, with persistent inventory build-ups, stagnant order books, and potential tariff implications from the incoming U.S. administration clouding the outlook. Meanwhile, rising bankruptcies since mid-2023 could further strain the labour market, dampening prospects for a private consumption-driven rebound. Complicating matters further, Germany’s upcoming elections have shifted political focus away from economic recovery toward immigration and the rise of the right-wing AfD, with recent parliamentary votes fuelling a heated debate on political cooperation with far-right factions. This shift in priorities, coupled with deepening divisions between centrist parties, risks delaying much-needed economic reforms and investments, leaving Germany’s path to recovery uncertain.

We believe that Germany, alongside France, will continue to be the biggest drag on Eurozone growth in 2025. Germany's economy shows stagnation, while France deteriorates further.

Germany’s inflation fell to 2.3% in January, unemployment rose to 6.2%, and the ECB is expected to continue rate cuts amid easing price pressures and labour market weakness.

Germany’s January inflation data provides some relief to the ECB, with headline inflation falling to 2.3% YoY from 2.6% in December, while core inflation declined to 2.9% from 3.3%, and the harmonized European inflation measure remained unchanged at 2.8%. Regional data indicates diverging energy price trends, with household electricity and gas prices decreasing month-on-month, whereas heating oil costs rose. Services inflation, though slightly lower, remains elevated at nearly 4% YoY, reflecting the delayed pass-through of higher costs. Meanwhile, the labour market continues to weaken, with German unemployment rising by 103,000 in January to a 10-year high of 2.9 million, pushing the unemployment rate to 6.2%, which dampens hopes for a strong consumer-driven recovery but reinforces disinflationary pressures. With inflation expected to stabilize between 2.0% and 2.5% in 2024, the ECB is likely to continue rate cuts, though the extent remains uncertain pending next week’s staff report, which may provide further insights into the neutral interest rate framework and future monetary policy direction.

We expect inflation to decline in the short term, but potential Trump tariffs in Europe could reverse this trend and drive inflation higher again.