European bonds saw volatility, with France’s outlook downgraded. Investor caution grew amid geopolitical tensions. The euro weakened, and Brent crude dropped 1.58%, influenced by global factors.

European government bonds saw significant volatility, with yields generally falling, leading to price increases. S&P downgraded France’s outlook from stable to negative, citing rising debt, political deadlock over budget deficits, and uncertain growth, although it maintained the country's rating at 'AA-/A-1+'. The spread between 10-year German government bonds and 10-year interest rate swaps hit a record low, signalling a decline in investor confidence in German debt, with markets anticipating potential easing of Germany's debt brake or the creation of a special fund, raising concerns of oversupply. Investor caution prevailed amid geopolitical tensions and inflationary pressures, while the stock market showed mixed results, with Spain leading the gains at nearly 3% for the week. The euro depreciated against the dollar, falling by 0.79%. Brent crude prices dropped 1.58%, influenced by discussions between the U.S. and Ukrainian presidents, the possibility of new tariffs from Washington, and Iraq's decision to resume oil exports from the Kurdistan region.

Germany's economy contracted by 0.2% in Q4 2024, driven by weak exports and investment. Inflation remained steady, while political fragmentation and economic stagnation signal challenges ahead, with recovery unlikely until late 2025.

Germany's economy contracted by 0.2% QoQ in Q4 2024, driven by a sharp decline in exports (-2.2%) and weak investment in machinery and equipment, while construction investment saw a modest 1.0% increase. Household consumption grew slightly by 0.1%, but manufacturing continued to struggle with a 0.6% decline in production. On a YoY basis, GDP fell 0.4%, with investments dropping 2.7% and exports down 3.2%, contributing to a drop in Germany’s global GDP share to 4.3%. Inflation held steady at 2.3% YoY, with food price inflation accelerating, while the core rate eased due to slower service price growth. Weak retail sales and labour market data dampened expectations for a recovery. Political uncertainty following fragmented elections complicates economic policy as coalition talks continue between CDU/CSU and SPD. The outlook remains challenging, with stagnation expected to persist into 2025, compounded by potential tariffs, rising energy costs, and geopolitical tensions.

Germany's economy contracted by 0.2% QoQ in Q4 2024, driven by a decline in exports and investments, highlighting the need for urgent economic revitalization.

Germany’s economy contracted by 0.2% QoQ in Q4 2024, following a modest expansion of 0.1% in the previous quarter. The decline was primarily driven by a significant reduction in exports, which fell by 2.2%, including a sharp 3.4% drop in goods exports, the largest decline since Q2 2020. Conversely, imports increased by 0.5%, with service imports rising by 4.2%. Gross fixed capital formation displayed mixed results: investments in machinery and equipment declined for the fifth consecutive quarter (-0.3%), while construction investment rose by 1.0%, supported by favourable weather conditions. Household consumption grew marginally by 0.1%, while government expenditure increased by 0.4%. The manufacturing sector continued to struggle, with a 0.6% decline in production, particularly in machinery, equipment, and motor vehicles. The services sector, however, showed resilience, posting overall growth of 0.5%, with public services, education, and health expanding by 2.5%. On a YoY basis, GDP fell by 0.4%, with investments dropping sharply by 2.7%, and exports declining by 3.2% compared to Q4 2023. Germany’s global GDP share reached a near-record low of 4.3%, down from 8.4% in the 1990s. These figures underscore the urgent need for the new government to prioritize revitalizing critical sectors, including industry, construction, and exports while fostering a more conducive environment for investment to spur economic recovery.

We expect the economy to remain stagnant, with potential Trump tariffs possibly deepening the downturn and creating additional challenges for the European power.

German inflation remained at 2.3% YoY in February, with mixed price trends, reinforcing expectations for a 25bps ECB rate cut next week.

Inflation remained unchanged in February, with consumer prices rising 2.3% YoY as food inflation accelerated to 2.4% from 0.8%, while the core rate eased to 2.6% from 2.9% due to a slowdown in service prices to 3.8% from 4.0% YoY. The broader European inflation measure also held steady at 2.8% YoY. Weak retail sales and labor market data further dampen hopes for a consumption-driven recovery, as January’s 0.2% MoM retail sales increase was insufficient to offset Q4 2024 weakness, and the labor market continued its gradual cooling. Inflationary trends remain mixed, with energy base effects and lower prices for alcohol, healthcare, and household goods exerting downward pressure, while food prices rebounded and service inflation showed only a slow decline, dropping to 3.8% from 4%. Headline inflation is expected to remain between 2% and 2.5% throughout the year, influenced by volatile energy costs, delayed pass-through of higher service prices, and ongoing labor market adjustments. Meanwhile, industrial firms’ rising selling-price expectations and potential European tariffs add further inflationary risks. With inflation data from Germany, France, and Italy reinforcing the case for a 25bps ECB rate cut next week, focus now shifts to the central bank’s policy direction, as officials weigh the possibility of moving from a restrictive stance toward a more neutral or even accommodative approach, potentially lowering rates to 2% to support economic stability amid the eurozone’s structural weakness.

We expect inflation to remain volatile, with slight rebounds depending on Trump’s policies.

Germany's elections left a fragmented landscape, with CDU/CSU winning but facing complex coalition talks, SPD weakened, AfD surging, and a grand coalition the most likely outcome.

Germany's recent elections marked a historic shift in its political landscape, with Friedrich Merz’s CDU/CSU securing victory at 28.6% but facing its second weakest result ever, while the far-right AfD surged to 20.8%, pushing traditional centrist parties into decline. The SPD suffered its worst-ever outcome at 16.4%, while the Greens (11.6%) and the Left Party (8.8%) struggled to maintain influence, and the FDP failed to meet the 5% threshold, leaving it out of parliament. The high voter turnout of 84% underscored both engagement and discontent, as far-right and far-left parties collectively gained almost 20 percentage points compared to 2021, reflecting deep political shifts. Coalition talks will be exceptionally challenging, given the CDU/CSU’s previous campaign attacks on the Greens and the SPD’s reluctance to re-enter a grand coalition as a junior partner. However, with limited alternatives, a CDU/CSU-SPD coalition remains the most feasible path forward, barring an unlikely shift towards AfD, which Merz has ruled out. Economic policy, immigration reform, and investment in infrastructure and defence will be key negotiation points, with potential compromises on taxation and deregulation. While Merz has set an ambitious goal of forming a government before Easter, success will depend on parties prioritizing national stability over political rivalry. The election results highlight Germany’s urgent need for economic renewal, and the next government must navigate fragmentation carefully to avoid prolonged instability and loss of public confidence.

We expect the government to remain largely unchanged, given the potential coalition agreement. Germany will continue to face structural challenges and struggle to break free from a stagnant and traditional economy.

Germany's economic stagnation deepens, with weakening consumer sentiment and labour market concerns. The new government faces urgent challenges to restore confidence and stabilize the economy.

The latest Ifo index presents a sobering reality for Germany’s incoming government, underscoring the persistence of economic stagnation and the absence of any cyclical momentum. The index showed a slight increase to 85.2 in February from 85.1 in January, yet the current assessment component declined to 85.0, reflecting ongoing stagnation. Adding to the concern, consumer sentiment has unexpectedly deteriorated, with the GfK Consumer Confidence Index falling from -22.6 to -24.7, its lowest point since April 2024. Economists had forecasted a modest improvement to -21.6, but weaker labour market data has amplified pessimism. These adverse trends place increasing pressure on the CDU/CSU and SPD to swiftly form a government capable of restoring confidence and addressing growing economic challenges. With the CDU securing the largest share of votes in Sunday’s election, positioning Friedrich Merz as the likely next chancellor, the new leadership must navigate immediate hurdles, including the potential for US tariffs, rising energy costs, and escalating geopolitical tensions. As consumer spending remains subdued, all eyes are on the coalition talks, with hopes that a timely resolution will stabilize the economy and restore much-needed confidence.

We expect consumer sentiment to remain volatile, especially in the short term, with no improvements anticipated until the last quarter of 2025.