European bond yields fell in Germany and Spain; equities were mixed; the euro rose; oil declined amid OPEC+ speculation and geopolitical tensions unsettled energy markets.

European bond markets declined over the week, with the exception of Germany and Spain, where yields continued to fall. The yield spread between French and German 10-year government bonds widened to 69.5 basis points. Equity markets showed a mixed performance, with Italy and France posting sharp losses of 2.90% and 1.93% respectively, while Portugal recorded a gain of 1.31%. The euro appreciated by 1.88% against the US dollar. In commodities, Brent crude oil fell 1.44% amid speculation over potential OPEC+ production increases and an unexpected rise in US crude inventories. Geopolitical tensions, including the ongoing US-Iran nuclear talks and the war in Ukraine, continued to weigh on sentiment in the energy sector.

Eurozone growth weakened in May as services contracted. Germany showed short-term resilience, but structural issues and global risks point to looming stagflation and uncertain recovery.

In May 2025, Eurozone growth faltered as the HCOB Composite PMI dropped to 49.5, indicating contraction due to a steep decline in services activity, while manufacturing showed slight improvement. Germany mirrored this trend, with its Composite PMI falling to 48.6 amid a 30-month low in services. However, inflationary pressures remained subdued, giving the ECB room to ease monetary policy. Despite weak activity, Germany's economy grew by 0.4% in Q1, fuelled by exports and consumption, though long-term challenges persist amid tariff uncertainty and structural weaknesses. Business sentiment improved slightly, with the Ifo index rising to 87.3, reflecting cautious optimism driven by expected fiscal stimulus. Still, delayed reforms and geopolitical risks cloud the outlook. Overall, while short-term resilience appears in German GDP and sentiment data, both the Eurozone and Germany face risks of prolonged stagnation. Stagflation looms in Germany, with weak growth and persistent inflation likely to shape the economic landscape through 2025.

Eurozone growth faltered in May as services contracted sharply, offsetting manufacturing resilience. Weak demand and low inflation support ECB easing, with risks tilted to the downside amid ongoing uncertainty.

The Eurozone economy showed renewed signs of weakness in May, as the HCOB Composite PMI fell to 49.5 from 50.4 in April, slipping back below the 50 threshold that separates growth from contraction. This decline was driven primarily by a sharp deterioration in the services sector—long the engine of Eurozone growth—with the Services PMI falling to 48.9, significantly below the forecast of 50.5. In contrast, the manufacturing sector displayed tentative signs of stabilization, with the Manufacturing PMI rising modestly to 49.4 against expectations of 49.2, buoyed by steadying new orders and a potential turnaround in the inventory cycle. Germany, the bloc’s largest economy, mirrored the Eurozone trend, with its Composite PMI dropping to 48.6—its first contraction in 2025—driven by a steep fall in services activity to a 30-month low of 47.2, while manufacturing remained flat at 48.8, supported by improving sentiment in defense and energy industries. Despite these weak figures, there are no indications of mounting inflationary pressures, giving the European Central Bank (ECB) greater flexibility to continue monetary easing, potentially moving rates to neutral or even below. Overall, the data point to persistent sluggishness in Eurozone activity, with elevated uncertainty—largely due to geopolitical tensions and the broader trade environment—weighing on demand, particularly in the service economy, and downside risks dominating the near-term outlook.

We expect the ECB to proceed with rate cuts in the coming months, as subdued inflation and weakening economic momentum—particularly in the services sector—warrant further monetary easing to support demand and confidence.

Germany’s economy grew 0.4% in Q1 2025, driven by exports and spending, but structural challenges and tariff uncertainty cloud long-term sustainability and competitiveness.

Germany’s economy delivered a stronger-than-expected performance in the first quarter of 2025, expanding by 0.4% QoQ—double the initial flash estimate of 0.2% and marking the strongest growth since Q3 2022—largely driven by frontloaded exports and industrial production ahead of anticipated U.S. tariffs under the renewed Trump administration. The rebound was underpinned by a 0.5% rise in private consumption, fuelled by a significant 7.5% QoQ drop in household savings, and a 0.9% increase in investment, while net trade contributed a robust 0.9 percentage points to overall GDP growth. On a year-on-year basis, however, the economy remained 0.2% smaller, underscoring the fragility of the recovery. March, in particular, saw a notable surge in industrial output and exports, timed around U.S. tariff threats and the so-called "Liberation Day" campaign rhetoric, temporarily boosting demand. Nonetheless, government consumption and inventories detracted from growth, and the tariff uncertainty—despite a current 90-day pause—continues to weigh on business sentiment and investment planning. While the quarter's results offer a rare upside surprise following months of downward revisions to growth forecasts, the outlook remains clouded by Germany’s weak structural momentum, sluggish productivity gains, and the new government’s cautious reform agenda. The administration now has access to substantial fiscal space, which it aims to channel into infrastructure and defence, but economists warn that without complementary efforts to enhance competitiveness, modern infrastructure alone will not drive long-term transformation. Though there are early signs of a turning inventory cycle that may support industrial activity in the near term, the broader macroeconomic environment—shaped by shifting global trade patterns and rising geopolitical risk—suggests the current momentum may not be sustainable. Still, the Q1 data marks a welcome shift in tone and could prompt upward revisions to 2025 growth forecasts if cautiously sustained.

We expect Germany to face a period of stagflation, where weak economic growth—driven by structural challenges and external shocks—coexists with persistent inflationary pressures from global trade disruptions and elevated energy costs.

Germany’s Ifo index rose in May, reflecting cautious optimism amid geopolitical uncertainty, with businesses hopeful about fiscal stimulus despite persistent structural challenges and slow policy execution.

German business sentiment improved in May, with the Ifo index rising to 87.3 from 86.9 in April, driven by a notable increase in expectations to 88.9—the highest level in a year—despite a slight dip in current conditions to 86.1. This improvement suggests a cautious optimism among German businesses, who appear to be focusing more on the potential opportunities presented by the new government and forthcoming fiscal stimulus than on the uncertainties surrounding US tariffs and global trade tensions. While the near-term outlook remains clouded by the economic drag of trade disruptions and a lack of structural reform ambition, the longer-term prospects could benefit from increased public investment in infrastructure and defense, provided these measures are implemented efficiently. Nevertheless, Germany continues to grapple with structural inertia, as the policy response to economic stagnation has been slow, hindered by political transitions and internal divisions. Though there are signs of a cyclical rebound—evident in early-year growth and frontloaded exports—persistent challenges such as weak competitiveness, geopolitical shifts, and delayed policy execution temper the outlook. Chancellor Merz’s promise of tangible improvements by summer may prove overly ambitious, as the effects of public investment typically materialize with a lag, leaving many Germans still waiting for meaningful change.

We expect stagflation in Germany this year, as persistent economic stagnation combines with elevated inflation, despite temporary optimism from improved business sentiment and upcoming fiscal stimulus.