European bond yields fell, with French bonds underperforming. The Ibex rose 4.5%, the euro weakened, and Brent crude dropped 2.37% amid rising US inventories.

European bond yields fell during the week, with French bond yields remaining above Spain's. France will once again miss its fiscal deficit targets, continuing a recurring trend. Against this backdrop, the yield (for the risk assumed) on French bonds remains notably low at 3.093%. The spread between the French 10-year bond and the German bond stands above 71 basis points. The stock market maintained positive momentum, with the Ibex leading the gains, up over 4.50%. The euro weakened against the dollar, ending the week at 1.0327. Brent crude oil prices dropped 2.37%, pressured by rising US crude inventories and Donald Trump's renewed commitment to increasing domestic oil production.

Eurozone inflation rose to 2.5%. Growth remains fragile. Germany's industry struggles. The BoE cut rates to 4.50%. Uncertainty remains over further cuts. Inflation and trade risks persist.

Eurozone inflation rose to 2.5% in January, marking a fourth consecutive increase, driven by energy costs, with core inflation steady at 2.7% and service inflation slightly lower at 3.9%. Disinflation is expected in 2025, but risks persist from energy prices, business cost pass-through, and potential US tariffs, while slowing wage growth may ease domestic pressures. Eurozone business activity showed slight growth, with PMI rising to 50.2, though weak export demand and inflationary pressures persist. Germany’s industrial sector struggled, with production down 2.4% MoM in December, remaining 10% below pre-pandemic levels, while exports rose 2.9% MoM, likely due to frontloading. Despite an increase in new orders, structural weaknesses continue to weigh on recovery. Meanwhile, the Bank of England cut rates to 4.50%, with forecasts of slow growth, rising unemployment, and persistent inflation. Markets expect four cuts in 2025, though inflation concerns could slow the pace. Overall, economic uncertainty, inflation risks, and trade tensions continue to challenge growth prospects.

Eurozone inflation rose to 2.5%, driven by energy prices, with risks lingering from energy costs, service inflation, and potential US tariffs, challenging ECB rate adjustments.

Eurozone inflation rose from 2.4% to 2.5% in January, marking the fourth consecutive increase, driven primarily by higher energy prices. Although inflation is expected to moderate throughout the year, inflationary risks remain, and core inflation holds steady at 2.7%. Service sector price gains dipped slightly to 3.9% from 4% but remain elevated. The outlook for 2025 suggests a disinflationary trajectory, though the extent remains uncertain. With wage growth anticipated to decrease significantly by year-end, a key driver of domestic inflation will fade. However, rising energy prices and businesses’ intent to pass on higher costs to consumers, as reflected in business surveys indicating stronger inflation in goods and services, pose ongoing risks. Moreover, the potential imposition of US tariffs on the EU raises concerns over retaliatory measures, which would likely worsen inflationary pressures. Despite the European Central Bank’s belief that inflation is under control amid a sluggish economy, the persistence of inflationary risks and mounting uncertainty raises questions about how much further the ECB can lower interest rates to provide the economy with additional support.

We expect inflation to rise slightly in the short term, but due to the economy's weakness, the ECB may lower rates further throughout the year.

Eurozone growth returned in January, with the composite PMI rising to 50.2. However, inflation pressures, weak export demand, and fragile recovery signal ongoing challenges.

Eurozone Composite PMI data for January 2025 revealed a slight recovery in output growth, with the composite PMI rising to 50.2 from 49.6 in December, marking the first expansion since August 2024. The services sector saw a modest slowdown, with the services PMI falling to 51.3 from 51.6, reflecting a softer pace of activity. Meanwhile, manufacturing output showed a marginal improvement, rising to 50.5 from 49.7, driven by a slower decline in production. Employment conditions stabilized, with job losses in the manufacturing sector being offset by a slight increase in the services sector. However, inflationary pressures persisted, with input costs rising at the fastest rate in 21 months, signalling heightened cost pressures. Despite these challenges, optimism about future growth improved, with confidence in the outlook reaching its highest level since July 2024, particularly in Germany, which recorded its strongest performance since May 2024. On a national level, Spain remained the main growth driver with a PMI of 54.0, while France continued to experience contraction at 47.6. Overall, while the Eurozone economy returned to growth, the recovery remains fragile, driven largely by the completion of backlogged orders rather than a significant rebound in new business, with ongoing inflation and weak export demand continuing to weigh on the region's outlook.

We expect the economy is still far from recovery. If Trump imposes tariffs, global inflation may rise, potentially impacting economic growth once again.

German industrial production fell 2.4% MoM in December, remaining 10% below pre-pandemic levels. Exports rose 2.9% MoM, driven by frontloading. New orders increased, but structural weaknesses continue to weigh on recovery.

German industrial production continued its downward trend in December, declining by 2.4% MoM after a 1.3% MoM increase in November, marking a YoY drop of over 3%. This confirms a weak end to the year for Germany’s economy, with the sector still struggling nearly five years after the onset of COVID-19. Industrial output remains about 10% below pre-pandemic levels, and manufacturing capacity utilization is at lows comparable only to those seen during the financial crisis and initial lockdowns. Meanwhile, exports grew by 2.9% MoM, with imports rising slightly more than 2% MoM, widening the trade surplus. However, this increase appears to be driven by frontloading ahead of anticipated tariffs rather than a sign of lasting recovery. Inventory levels remain elevated, indicating ongoing weakness in demand, while order books, despite showing signs of bottoming out, are still not robust enough to trigger a turnaround. Additionally, geopolitical uncertainties and trade tensions pose further risks, particularly with looming tariffs on EU goods and potential shifts in U.S. economic policy that could incentivize companies to relocate production. These factors, combined with weak domestic investment, reinforce the view that German industry will continue to act as a drag on overall economic growth.

New manufacturing orders provided a brief positive signal, rising 6.9% MoM in December after seasonal adjustments, though much of this was due to large-scale orders in the transport equipment sector, particularly for aircraft, ships, and military vehicles, which surged 55.5% MoM. Excluding these, orders rose by a more modest 2.2% MoM, while the three-month-on-three-month comparison remained flat. Domestic orders increased 14.6% MoM, largely due to major contracts, while foreign orders saw only a 1.4% MoM rise, with Eurozone demand up 6.2% MoM but orders from the rest of the world declining 1.5% MoM. While this data suggests short-term resilience, structural weaknesses in Germany’s industrial sector remain a significant concern.

Germany's lack of investment in recent years and reliance on a stagnating traditional industrial model continue to hamper growth. We expect it to remain among the Eurozone's weakest-performing economies.

The Bank of England cut rates to 4.50%, forecasts lower growth, persistent inflation, and rising unemployment, with markets expecting four cuts in 2025 amid cautious but gradual easing.

The Bank of England has cut interest rates by 25 basis points to 4.50%, with committee members Catherine Mann and Swati Dhingra advocating for a steeper 50bp reduction. Mann’s shift from a hawkish stance to supporting deeper cuts signals a push for a “clear signal” on policy direction, though the broader committee remains cautious. Given the UK mortgage market’s structure, where fixed-rate lending delays the impact of rate changes, some argue for front-loading cuts to accelerate economic pass-through. Despite this dovish tilt, the Bank’s latest forecasts remain relatively hawkish, with CPI inflation expected to peak at 3.0% in Q1 2026 before easing to 2.3% in Q1 2027, while GDP growth is projected at 0.4% in Q1 2025, rising to only 1.3% in Q1 2027—lower than previously estimated. Unemployment is set to increase from 4.5% to 4.8% over the same period, indicating labour market fragility. The Bank Rate is forecast to decline from 4.6% in Q1 2025 to 4.1% in Q1 2027, reinforcing expectations of gradual monetary easing. Markets now price in four rate cuts in 2025, with reductions anticipated in May, August, and November, though a faster pace remains possible if services inflation falls more sharply, or labour market weakness intensifies.

We do not expect four rate cuts this year, as we are less optimistic than the market. Inflation remains high and has recently rebounded.