European bond yields rose, stock markets were mixed, the euro weakened, and Brent crude prices surged amid supply constraints.

European bond yields rose throughout the week, with UK 10-year yields reaching 4.84%, their highest level since August 2008, while Germany's 10-year yield widened to 2.57% amid persistent default risk concerns. The UK-Germany 10-year yield spread hit 227 basis points, its highest since the "Liz Truss moment" in 2022. Stock markets ended mixed, with sharp declines in Portugal (2.44%) and the UK (4.16%). The euro weakened against the dollar, closing at 1.0244. Brent crude oil prices surged 4.04%, driven by supply constraints as OPEC production fell by 50,000 barrels per day in December due to UAE maintenance and declining Iranian output, aligning with OPEC+’s supply-limiting strategy. Saudi Arabia and Iraq maintained steady production, while Western sanctions on Russian crude and U.S. efforts to restrict Russian exports tightened supply further. Expectations of a 300,000 bpd drop in Iranian output added to concerns, pushing prices higher despite demand uncertainties.

Eurozone inflation hit 2.4% in December 2024, driven by energy and services. Economic fragility, weak demand, and inflationary pressures challenge recovery prospects for 2025.

Eurozone inflation reached 2.4% in December 2024, driven by rising energy prices and higher services costs, marking a third consecutive month of increase. Energy prices surged as natural gas and oil costs rose, while services inflation climbed to 4.0%, reflecting robust wage growth. Despite the ECB’s forecast of a slight decline in inflation to 2.3% by early 2025, the outlook remains uncertain, with concerns over stagflation and economic fragility. The Eurozone economy contracted, driven by weak demand and falling employment, particularly in manufacturing. Germany experienced a brief industrial rebound in November, but weak orders and high inventories limited long-term recovery prospects. The region faces challenges in 2025, including geopolitical uncertainties and inflationary pressures.

Eurozone inflation rose to 2.4% in December 2024, driven by energy and services. ECB's cautious easing faces challenges amid stagflation fears and economic fragility.

Eurozone inflation continued its upward trajectory for the third consecutive month, with headline inflation reaching 2.4% in December 2024, up from 2.2% in November, while core inflation held steady at 2.7%. Energy prices have become a significant driver, transitioning from a year-on-year decline of 6.1% in September to a positive inflation rate of 0.1% in December, as natural gas prices surged by over 50% compared to the previous year, and oil prices ceased their decline. Unprocessed food inflation rose to 1.7%, supported by a reversal in agricultural commodity prices, which had dropped significantly in 2024 but are now climbing again. Goods inflation remained subdued at 0.5% for the fifth consecutive month, while services inflation increased to 4.0% from 3.9% in November, reflecting robust wage growth and sustained pricing power among service providers. The ECB projects headline inflation to decline to 2.3% in the first quarter of 2025, citing negative energy inflation as a key factor. However, current data suggests this forecast may be overly optimistic. Although the ECB is expected to continue its cautious easing strategy, the Governing Council remains wary of “looking through” supply-driven inflation shocks, indicating that the pace of monetary loosening is unlikely to accelerate, leaving critics of the ECB’s approach increasingly sceptical of its timing and responsiveness.

In Germany, inflation ended 2024 on a stronger-than-expected note, with December’s annual rate rising to 2.6% from 2.2% in November, and up significantly from 1.6% in September. This increase, driven by waning favourable energy base effects, rising wages, and sharp service cost hikes—such as a nearly 30% year-on-year surge in insurance premiums—has reignited fears of stagflation amid weak economic sentiment. Although inflation is projected to moderate to between 2% and 2.5% later in 2025 as wage growth slows, the ECB's current deposit rate of 3% remains restrictive, given the Eurozone’s fragile economic conditions. Managing structural economic challenges and regional political instability will remain critical as the ECB navigates this complex environment.

We anticipate that the ECB will continue its rate-cutting cycle, albeit at a more moderate pace than market expectations suggest. While inflation in the Eurozone may experience minor rebounds in the short term, the overall trend is expected to show a gradual decline, reflecting the easing of upward pressures from energy prices and a potential slowdown in wage growth later in the year.

The Eurozone economy ended 2024 in contraction, with weak demand, falling employment, and rising inflation. Manufacturing struggled, while services showed modest resilience, leaving 2025 uncertain.

The Eurozone economy ended 2024 in a fragile state, as revealed by the latest PMI survey data, with activity levels contracting for the second consecutive month in December. The composite index rose slightly to 49.6 from November’s 48.3, still indicating contraction but at a slower pace. This downturn was primarily driven by a sharp decline in manufacturing output, while services activity rebounded modestly, growing at a rate of 51.6, though still weaker than the survey average. Demand remained weak across both sectors, with new orders falling for the seventh straight month. Employment in the Eurozone also decreased in December, with manufacturing job cuts being more significant, leading to an overall reduction in workforce capacity despite modest hiring in services.

Inflationary pressures intensified in December, with input costs rising at their fastest pace since July, and services prices continuing to increase at a four-month high. Manufacturing saw a significant drop in export demand, marking nearly three years of decline. However, business sentiment showed some improvement, with growth expectations for the coming year rising to a 3-month high, though still subdued compared to historical averages. Despite this, the resilience in services helped offset some of the manufacturing weakness. The outlook for 2025 remains uncertain, with concerns over weak demand and potential external pressures, such as trade tensions, likely to impact overall Eurozone growth.

The countries within the Eurozone exhibited varying performances according to the Composite PMI Output Index. Spain led the group with a score of 56.8, marking a 21-month high, followed by Ireland at 52.1. Italy registered 49.7, while Germany's performance stood at 48.0, a two-month high. France recorded the weakest performance at 47.5, although this represented a two-month improvement, keeping the country firmly in contraction territory.

We expect uncertainty in the first half of the year due to potential tariffs from Trump-era policies. Additionally, we anticipate that the unemployment rate in the EU could increase slightly in the first quarter of 2025.

Germany's industrial rebound in November offers short-term relief but remains insufficient to avoid stagnation, with weak orders, high inventories, and persistent challenges hindering recovery prospects.

The recent rebound in German industrial production and exports, with industrial output increasing by 1.5% in November after a 0.4% decline in October, offers some short-term relief. Exports also rose by 2.1% MoM in November, while imports dropped by 3.3%. Notably, exports to the US, China, and the UK rose sharply, providing a glimmer of optimism. However, this rebound is insufficient to prevent another quarter of stagnation, as industrial production remains almost 3% lower than in the same period last year. This increase in activity is primarily a technical recovery following two months of contraction, rather than a sign of sustained growth. The broader economic environment, marked by persistently high energy prices and weakening global demand, continues to hamper long-term industrial recovery, with manufacturing capacity utilization remaining near crisis levels, comparable to the lows of the 2008 financial crisis.

The outlook for the German industrial sector is worrying, with industrial orders plummeting by 5.4% MoM in November, following a 1.5% decline in October. On an annual basis, orders were down by around 2%. Furthermore, inventories have remained elevated, signalling that production is unlikely to accelerate in the near future. Given these trends, and with industrial order books showing an average drop of 1% MoM since January 2024, the coming months are expected to continue this weak performance. The structural and cyclical challenges faced by Germany’s manufacturing sector, combined with geopolitical uncertainties, such as the potential for tariffs and policy changes under the incoming U.S. administration, suggest that a robust recovery remains out of reach. Without significant investment and structural reforms, it seems likely that Germany will experience another year of stagnation, with minimal prospects for a strong economic turnaround.

We expect Germany to remain a drag on Eurozone economic growth for another year. The country is trapped by its structural problems and is not evolving, staying anchored in a traditional economic model that hinders broader recovery.