European bond yields rose moderately with widening Franco-German spreads; the euro strengthened, Brent crude gained on positive U.S. jobs data and renewed U.S.-China trade talks.

European bond markets declined, leading to a general increase in yields, with the Franco-German 10-year spread widening to 67.2 basis points as risk differentials grew. While European yields rose under global market pressures, the moves were more moderate than in the U.S. or Japan. Italian bonds saw some relief as investor sentiment improved, while concerns around high debt levels in France and the U.K. have eased slightly compared to last year. Equity markets advanced, with Germany and Italy rising 1.28%. The euro appreciated 0.40% against the U.S. dollar, reaching its strongest weekly close since July 2023. Brent crude oil gained 5.19%, its first weekly increase in three weeks, supported by strong U.S. payroll data and renewed U.S.-China trade talks, which boosted global growth expectations.

ECB cut rates to 2% as inflation falls below target; eurozone GDP grew 0.6%, led by exports, but growth remains fragile with weak services and mixed business confidence.

The European Central Bank cut interest rates by 25 basis points to 2% amid declining inflation, soft economic momentum, and rising disinflation risks. Inflation fell below the ECB’s 2% target in May, with core inflation easing to 2.3%, driven by lower services and energy prices and subdued demand. GDP rose 0.6% in Q1 2025, led by exports and investment; however, Ireland’s 9.7% growth distorted the average, as excluding it, growth slows to 0.2%. Employment rose modestly by 0.2%. Despite the GDP rebound, business activity remained weak in May, with services contracting and manufacturing barely improving. The ECB maintained a data-dependent stance, signalling potential further easing but cautioning against overdoing rate cuts. German factory orders rose 0.6% in April, bolstered by electronics and transport sectors, but foreign demand remained mixed. Looking ahead, growth is expected to remain modest, with inflation risks tilted to the downside and monetary policy staying accommodative to support a fragile recovery amid geopolitical and trade-related uncertainties.

The ECB cut rates to 2% amid falling inflation, economic weakness, and rising disinflation risks, signalling possible further easing while maintaining a data-dependent approach.

The European Central Bank (ECB) has lowered interest rates for the eighth time in the past year, cutting the deposit rate by 25 basis points to 2%, the lowest level since December 2022, as eurozone inflation fell below the ECB’s 2% target and economic momentum weakened. This decision reflects growing concerns that inflation may remain below target for an extended period, driven by mounting disinflationary pressures from a stronger euro, a sharp drop in global energy prices, and subdued domestic demand. Economic growth faces headwinds from ongoing trade tensions, erratic U.S. policy decisions, and lingering supply shocks. While temporary boosts from export frontloading and industrial output have provided some resilience, structural weaknesses persist. The ECB’s latest staff projections forecast headline inflation at 2.0% in 2025, dipping to 1.6% in 2026 before returning to 2.0% in 2027, alongside GDP growth averaging 0.9% in 2025 and rising to 1.3% in 2027, underscoring the need for continued monetary accommodation. Despite the rate cut, the ECB emphasized it is not pre-committing to a fixed policy path and remains data-dependent. The central bank’s balance sheet has contracted to €6.3 trillion, reflecting the unwinding of pandemic-era asset purchases and gradual policy normalisation. ECB President Christine Lagarde highlighted the importance of flexibility amid heightened uncertainty from volatile financial conditions, fragile confidence, and geopolitical risks, aiming to support economic activity and maintain price stability.

Following this cut, the ECB signalled a likely pause over the summer, with Board members reluctant to further reduce rates at the July meeting unless trade tensions worsen significantly. The ECB views the recent acceleration of disinflation primarily as transitory—driven by energy prices and the stronger euro—favoring a wait-and-see approach. Nevertheless, further easing remains possible, with the potential for one more rate cut in September, as disinflationary pressures could spill over into the domestic economy, and a cooling labour market is expected to dampen wage growth. Longer-term optimism, supported by German fiscal stimulus and increased European defence spending, may limit the scope for additional cuts. Overall, the ECB anticipates approaching a neutral rate near 2%, expects no more than two further cuts this year, and may pause between 2% and 1.75% to reassess developments, with a return to near-zero rates considered unlikely.

We are in line with expectations, anticipating that neutral rates are near, with no more than one additional cut this year. The ECB may pause around 2%–1.75% to reassess, as we do not foresee a return to rates near zero. At this point, further cuts are unnecessary — the ECB should avoid overstepping and not “overdo it”.

Eurozone inflation fell below 2% in May, driven by lower services and energy prices, a stronger euro, subdued demand, slower wage growth, and trade-related economic uncertainty.

Eurozone inflation declined notably in May, with core inflation falling to 2.3% and headline inflation dropping below the ECB’s 2% target to 1.9%, marking the first time inflation has dipped under this threshold since September 2023. This decrease was driven primarily by a reduction in services inflation from 4% to 3.2%, its lowest level since March 2022, alongside continued declines in energy prices (-3.6% year-on-year) and stable non-energy industrial goods inflation at 0.6%. Conversely, food, alcohol, and tobacco prices rose by 3.3%, up from 3.0% the previous month, reflecting ongoing supply-side pressures in these sectors. Factors such as a stronger euro against the dollar, falling global commodity prices, muted economic activity amid trade uncertainties, and the European Commission’s cautious approach in refraining from retaliatory tariffs on the US have collectively contributed to the downward pressure on inflation. Although the sharp decline in services inflation may not be entirely structural—supported by recent survey data indicating a somewhat higher underlying trend—wage growth has slowed significantly despite record-low unemployment at 6.2%, limiting medium-term core inflation risks. Additionally, subdued consumer demand and cautious business investment further support the disinflationary trend.

We expect that Eurozone inflation will remain uncertain, as easing core pressures are balanced by ongoing supply-side challenges and fluctuating wage growth dynamics.

Eurozone GDP rose 0.6% in Q1 2025, driven by exports and investment, with Ireland distorting growth figures; Spain matched the average, and employment increased slightly.

The Eurozone economy expanded by 0.6% quarter-over-quarter in the first quarter of 2025, surpassing market expectations and marking the region’s fastest growth rate since Q3 2022. This performance, up from an earlier estimate of 0.3%, was primarily driven by a 1.9% increase in exports and a 1.8% rise in investment, both showing strong rebounds from the previous quarter. Spain matched the eurozone average with 0.6% growth, outperforming Germany (+0.4%), Italy (+0.3%), and France (+0.1%), reflecting solid momentum among the bloc's largest economies. At the country level, Ireland posted a striking 9.7% quarterly gain—by far the highest—followed by Malta (+2.1%) and Cyprus (+1.3%), while Luxembourg (-1.0%), Slovenia (-0.8%), Denmark, and Portugal (both -0.5%) saw the steepest declines. Despite accounting for only 4% of the Eurozone’s GDP, Ireland contributed approximately 50% of the area’s total growth over the past year, significantly distorting the regional average; excluding Ireland, the Eurozone’s average quarterly growth over the last four quarters drops from 0.4% to just 0.2%, indicating more modest underlying performance. Employment in the euro area rose 0.2% during the quarter, while annual employment growth reached 0.7%. The European Central Bank, in its latest projections, expects Eurozone GDP to grow by 0.9% in 2025, 1.1% in 2026, and 1.3% in 2027, reflecting a cautiously optimistic outlook amid persistent structural and external headwinds.

We expect further deterioration due to Ireland’s unusually outsized performance, which masks underlying Eurozone weakness; excluding Ireland, growth slows sharply, signalling fragile momentum ahead.

Eurozone growth remained weak in May as services contracted and manufacturing modestly improved. Demand softened, inflation eased, and business confidence rose slightly but stayed subdued.

The Eurozone economy registered a marginal expansion in May, with the HCOB Eurozone Composite PMI dipping to 50.2 from April’s 50.4—a three-month low and the softest growth since February. Although this marked the fifth consecutive month above the 50.0 threshold, the overall expansion was modest. Services activity contracted for the first time since November, falling to 49.7, while manufacturing continued to underpin growth. The HCOB Eurozone Manufacturing PMI rose to a 33-month high of 49.4 (up from 49.0), supported by a third consecutive monthly increase in output—the joint-fastest since March 2022—though overall growth remained moderate. Greece and Spain led manufacturing improvements, with Spain returning to expansion after three months of decline. France’s industrial sector nearly stabilised, reaching a 28-month PMI high, while Germany continued to lag, though its downturn was among the softest in three years. Across the region, demand conditions remained fragile, with new business and export orders falling for the thirty-ninth straight month. Firms continued depleting backlogs to offset weak demand and held back on hiring, though services employment grew slightly. Inflationary pressures eased, largely due to falling input costs and output prices in manufacturing, even as service sector inflation remained elevated. Italy and Spain drove private sector growth—Italy hitting a 13-month high—while France approached stabilisation and Germany posted its first contraction in five months. Business confidence improved for the first time since January, though it remained below historical averages.

We expect Eurozone growth to remain modest in the near term, with manufacturing providing some support while services struggle, though easing inflation and upcoming ECB rate cuts may gradually lift business sentiment and activity in the second half of 2025.

German industrial orders rose 0.6% in April, driven by strong electronics and transport sectors, with domestic demand growing despite slight declines in foreign orders.

German industrial orders in April 2025 demonstrated a continued cyclical recovery, with manufacturing orders unexpectedly rising by 0.6% month-on-month despite concerns that escalating US tariffs might suppress demand for German goods. This followed a strong 3.4% increase in March and resulted in a 4.8% year-on-year gain, indicating that the recovery extends beyond export frontloading. The positive momentum was largely driven by substantial growth in the manufacture of computer, electronic, and optical products, which surged 21.5% due to several large-scale orders. Other key contributors included new orders for other transport equipment—such as aircraft, ships, trains, and military vehicles—which rose 7.1%, and fabricated metal products, up 4.4%. Conversely, declines in electrical equipment (-9.2%), machinery and equipment (-4.2%), and pharmaceuticals (-14.1% following a strong rebound in March) moderated overall gains. New orders for capital goods increased by 4.1%, while intermediate and consumer goods orders fell by 3.4% and 5.9%, respectively. Foreign orders decreased slightly by 0.3%, with a 0.5% rise from Eurozone countries offset by a 0.9% drop from outside the Eurozone, whereas domestic orders grew by 2.2%. Collectively, these trends indicate a broadening and more balanced cyclical rebound in German industrial activity, supported by diverse sectors and a solid domestic market.

Germany continues to face structural challenges; however, the recent order growth is a positive signal, and planned defense and infrastructure spending could improve the situation. We believe it is still too early to say that Germany will fully recover, and we expect the country to experience stagflation this year.