European bonds fell, and yields rose with expectations of higher military spending. Stoxx Europe 600 gained. DAX is up 11.30% YTD.

European government bonds saw a decline in prices, causing yields to rise, driven by expectations of increased military spending and government borrowing. This surge in defence expenditure within the Eurozone is evident across several market segments, including curve steepening, government underperformance in swaps, and defence stocks outperforming the index. The stock market demonstrated resilience, with the Stoxx Europe 600 index rising, fuelled by gains in the banking sector, which marked its longest winning streak in nearly 30 years. Despite ongoing issues with the German economy, the DAX is up 11.30% year-to-date. The euro weakened against the dollar, closing the week at 1.0458. Meanwhile, Brent crude oil prices declined, partly driven by speculation that the Ukraine war may be nearing an end. Additionally, the Kazakh company overseeing the pipeline recently targeted by Ukraine confirmed continued uninterrupted operations, while lower-than-expected crude oil demand is anticipated.

The Eurozone PMI signals stagnation, with Germany showing recovery signs and France facing contraction. Rising costs and subdued demand lead to weak short-term prospects and ECB rate cuts.

The Eurozone PMI for February remained at 50.2, signalling stagnation with weak short-term prospects due to declining new orders and reduced hiring. Germany shows some recovery, with its composite PMI rising to 51.0 and a positive shift in its manufacturing orders-inventories ratio, while France faces continued contraction, with a composite PMI of 44.5. The overall Eurozone manufacturing PMI improved slightly from 47.1 to 48.7, suggesting a slower pace of contraction, but services growth is limited by weakening new business. Consumer confidence remains low, and household consumption is muted, holding back services activity. Input costs are rising, putting upward pressure on production prices, and the ECB is expected to continue cutting rates. Germany's ZEW Economic Sentiment Index rose to 26.0 in February, driven by optimism over reforms and upcoming elections, though current conditions remain weak. A change in government may help stimulate Germany's recovery by the end of 2025.

The Eurozone PMI signals stagnation, with weak short-term prospects. Germany shows signs of recovery, while France faces continued contraction, amid rising costs and uncertain demand.

The Eurozone PMI for February remains at 50.2, indicating a stabilisation in economic activity, but the short-term outlook remains weak due to declining new orders and reduced hiring. Despite a more optimistic tone in the stock market, the overall economic environment continues to exhibit stagnation rather than recovery. France is a particular area of concern, with the composite PMI falling to 44.5 (from 47.6 in January), driven by a manufacturing PMI of 45.5 and a services PMI dropping to 44.5, indicating contraction in both sectors. In contrast, Germany displayed more positive momentum, with the composite PMI rising to 51.0 (from 50.5), supported by a manufacturing PMI of 46.1 (up from 45.0) and a services PMI of 52.2 (unchanged). Notably, Germany's forward-looking orders-inventories ratio in manufacturing turned positive for the first time since March 2022, signalling potential future growth, whereas France’s ratio remains deeply negative, highlighting the divergent trends within the region. The overall Eurozone manufacturing PMI improved slightly from 47.1 to 48.7, indicating a slower pace of contraction. While services are still expanding, this is largely driven by slower growth in new business, and consumer confidence, though marginally higher in February at 96.8, remains well below long-term averages. Subdued household consumption, exacerbated by global uncertainty, continues to constrain service activity. With orders still declining, businesses reducing workforces, and the potential for disruptive tariffs, the economic outlook for the coming months remains highly uncertain. Despite the European Central Bank's confidence in controlling inflation, rising input costs, as flagged by the PMI, are being passed onto consumers, maintaining upward pressure on production prices. Given the weak demand environment, a significant inflationary surge is unlikely in the medium term, and the ECB is expected to continue its policy of rate reductions for the time being.

Despite inflation concerns, we expect the ECB to continue cutting rates throughout the year. The EU economy requires stimulus to avoid falling into recession.

Germany's ZEW Economic Sentiment Index rose to 26.0 in February, driven by optimism over reforms and elections, though current conditions remain weak amid ongoing economic challenges.

Germany's ZEW Economic Sentiment Index surged to 26.0 in February, marking its highest level in two years and surpassing both the expected 20.0 and January's 10.3. This notable increase in investor confidence is largely driven by optimism over potential economic reforms and hopes for a more effective German government following the upcoming federal elections. However, the rise was largely seen in the expectations index, while the current conditions index remains deeply negative at -88.5, slightly better than the forecasted -90.0 and January's -90.4. Despite the positive shift in sentiment, the economy continues to face structural challenges, including high energy costs, global competition, and restrictive monetary policies. While the improved outlook has bolstered market confidence, uncertainties regarding political stability and the pace of economic recovery cast doubt on the sustainability of this optimism. ZEW President Achim Wambach attributed the rising optimism to expectations of stronger private consumption after a period of weak demand, although the path to full recovery remains uncertain.

We anticipate that a change in government could gradually stimulate a recovery in Germany, the EU's largest economy, by the end of 2025.