The decline in confidence indicators across the eurozone observed since the start of the conflict in the Middle East had suggested a slowdown in momentum within the region. The moderation in the pace of growth during the first three months of the year (+0.6% on an annualised quarterly basis) therefore came as little surprise. Among the major European economies, Germany performed well (+1.3%), driven by robust private and public consumption, reflecting an expansionary fiscal policy. By contrast, France disappointed, with GDP stagnating over the quarter, hampered by weak household consumption and construction activity.
A gloomy outlook
The ongoing blockade of the Strait of Hormuz, which has lasted for more than two months, is significantly weakening the outlook for European growth. In April, the leading composite PMI index continued to fall, dropping below the 50-point mark (48.8), reflecting a further weakening of activity in the services sector, which has been affected by lower consumer demand. The resilience observed in the manufacturing sector should not be extrapolated, as it reflects, at least in part, expectations of orders against a backdrop of upward pressure on prices and potential disruptions to supply chains.
Monetary tightening is already underway in the eurozone
The German two-year yield has risen by more than 0.6% since the start of the year and currently stands at around 2.75%. This sharp rise in short-term rates reflects expectations of a tightening of ECB policy: the markets are pricing in two to three rate rises by the end of 2026, with the first hike expected as early as June. Long-term yields are also on an upward trajectory, driven by a rebound in inflation expectations. In Germany, the market now expects average annual inflation of around 2.3% (compared with 1.75% at the start of the year) over the next ten years.
Furthermore, the ECB’s latest survey on bank lending in the euro area revealed a further tightening of lending conditions for businesses during the first three months of the year. This cautious stance, which is set to continue into the second quarter of the year, is largely due to greater risk aversion within the banking sector.
ECB survey on lending: changes in credit conditions for businesses (net percentage). (Source: ECB, Banque de Luxembourg)
The price per barrel remains above $100
The price of Brent crude, the benchmark North Sea oil, has stabilised in recent weeks at around $110, slightly below its recent high. This relative calm on the price front can be attributed to two factors. Firstly, the sharp rise in seaborne exports from the United States. Secondly, China’s increased use of domestic stocks, meaning it is relying less on imports. However, neither of these factors appears to be sustainable. Given the sharp decline in global stock levels, a swift reopening of the Strait of Hormuz in the coming weeks is essential to prevent a further surge in oil prices.
A resilient US economy
US gross domestic product grew by 2% on an annualised quarterly basis during the first three months of the year, driven by moderate growth in household consumption expenditure (+1.6%). The latest consumption indicators – particularly retail sales for April – do not suggest a more pronounced slowdown in spending at this stage. Substantial tax refunds, a consequence of the ‘One Big Beautiful Bill Act’, which introduces tax cuts with retroactive effect from 2025, are providing some relief to households in this inflationary environment. Technology investment also continues to provide significant support to the US economy, contributing over 1% to growth over the quarter. This trend is expected to continue: for example, when announcing their first-quarter results, Meta Platforms, Microsoft, Google and Amazon.com all revised their capital expenditure plans upwards, with total spending collectively expected to exceed USD700bn by 2026.
A labour market that shows no clear signs of slowing down
Job creation in the private sector in April met expectations, coming in at 123,000. On a smoothed basis, between February and April, 55,000 jobs were created on a monthly average, a level sufficient to prevent a rise in the unemployment rate. Nevertheless, we continue to see significant concentration at sectoral level, with sustained job creation in healthcare and social care.
Monetary policy remains unchanged, whilst interest rates have also risen sharply
The resilience of economic growth and the labour market, coupled with soaring inflation – the Consumer Price Index rose by 3.8% year-on-year in April, the sharpest increase recorded since 2023 – are all factors that justify keeping monetary policy unchanged in the United States.
Short-term rates have, like those in the eurozone, rebounded sharply. The two-year yield has risen by more than 0.6% since the start of the year. Meanwhile, 30-year yields have reached their highest level since 2007! The newly appointed Federal Reserve Chairman, Kevin Warsh, inherits an economic environment that will likely not allow for the monetary easing hoped for by the Trump administration.
US interest rates. (Source: Bloomberg, Banque de Luxembourg)
Equity markets are buoyant despite pressure on interest rates
Despite significant tensions in the bond markets and limited visibility regarding the outcome of the conflict in the Middle East, equity markets have rebounded sharply since the start of April. This rebound is mainly attributable, on the one hand, to robust corporate earnings as reflected in the excellent first-quarter results, particularly in the United States, and, on the other hand, to investors’ continued strong interest in the theme of artificial intelligence. The market rally appears somewhat fragile, however, as it is concentrated in a small number of stocks.
