By Michael Krautzberger, Global Chief Investment Officer Fixed Income at Allianz Global Investors
Euro area data suggests that regional activity is slowing in Q4 2024, with surveys of manufacturing activity remaining weak and clouds also gathering in the service sector. Consumer confidence is waning and labour market data shows some deterioration, with surveys painting a picture of softening employment growth.
And on the inflation front, the broad disinflation narrative remains intact, with Euro headline and core CPI inflation at 2.3% y/y and 2.7% y/y, respectively, in November. In the short term, the structural challenges, trade uncertainty and policy paralysis facing the region – as we await the German federal elections in February and the outcome of the French budgetary process – presents a rather downbeat picture for European prospects as we head towards 2025.
While the recent activity data in the region would not preclude a 50bp cut at the December meeting and a quicker removal of the restrictive policy stance, recent comments from some ECB policymakers have varied on the rate path ahead. Executive board member Schnabel, in particular, has advocated for a more gradualist approach given concerns that the inflation journey to 2% may still be bumpy in 2025 and given her belief that the impact of past ECB tightening is fading fast.
It certainly isn’t all bad news for the region looking into 2025. Financial conditions are easing, helped by ECB rate cut expectations and a weaker Euro. The most recent ECB bank lending survey also highlighted improving loan demand in the region, while the prospect of German debt brake reform in 2025 could provide the German government with some fiscal space to address the structural and cyclical challenges facing the economy.
Nonetheless, much will depend on future US tariff policy; broad-based tariffs on both China and Europe could quickly derail any hopes of a durable recovery in the region.
From a strategy perspective, We favour German yield curve steepeners in the near-term, but we recognize that a lot of bad news is now well priced in interest rate markets.
