​​European indices face pressure from political instability and credit concerns​

Political turbulence impacts European markets

European markets retreated as political turbulence in major economies and credit rating concerns dampened investor sentiment.

Chancellor Olaf Scholz's government collapsed following a successful no-confidence vote on Monday, 16 December, triggering early elections for 23 February. The crisis emerged after Scholz dismissed Finance Minister Christian Lindner, leader of the Free Democrats, losing his parliamentary majority. Coalition tensions had been building over Ukraine funding and economic policy. The political uncertainty adds to Germany's existing economic challenges.

Chancellor Olaf Scholz

Economic outlook for Germany

According to the European Commission, Germany's economy faces a contraction of 0.1% in 2024 amid high uncertainty impacting consumer spending and business investment, while weakening global industrial demand hampers trade performance.

The Commission projects a gradual recovery, though, with gross domestic product (GDP) growth reaching 0.7% in 2025 and strengthening to 1.3% in 2026, supported by anticipated real wage increases boosting domestic demand.

This outlook suggests Europe's largest economy has experienced a challenging 2024 before returning to growth in the years to come, with the government deficit expected to narrow and the debt-to-GDP ratio stabilising around 63%.

DAX 40's resilience amid challenges

The forecast underscores the current challenges facing the German stock market (DAX 40) but points to potential improvement in the medium-term. Despite these challenges, the DAX 40 hit record highs in mid-December, benefiting from France’s political turmoil.

​European stock indices year-to-date comparison chart

European markets face headwinds from German-French political uncertainty

The combined German-French political uncertainty creates significant headwinds for European markets, especially when compared to US markets, which have seen their largest ever inflows as investors believe the US economy to be in a ‘goldilocks’ scenario, i.e., neither too hot nor too cold; just right.

According to the BofA Global Fund Manager Survey, fund manager cash allocation fell to its lowest level on record in December.

​Fund manager cash allocation survey chart 2001-to-2024

UK economic indicators show resilience

When looking at the UK, the HCOB composite purchasing managers index (PMI) improved to 49.5. Although still in contraction territory, it rose from 48.3, beating its 48.2 forecast. The UK composite PMI held steady at 50.5, marking 14 months of consecutive expansion. These figures provided some relief from concerns about Trump's proposed tariffs. The data suggests underlying economic resilience despite political challenges.

Wage growth and inflationary pressures

UK wage growth beating forecasts may create inflationary pressure, as regular pay in the UK, excluding bonuses, increased by 5.2% year-on-year (YoY) in the three months to October, versus a forecast of 5.0%. The rise is slightly higher than the previous 4.9% reading, which was the lowest since June 2022. Even though wage growth accelerated in the private sector, it continued to slow in the public sector, while unemployment held steady at 4.3%.

Bank of England outlook

The Bank of England (BoE) maintained rates at 4.75% in November after two cuts in the current cycle. Markets expect rates to remain unchanged at Thursday's meeting. Core inflation, currently at 3.3%, is projected to rise to 3.4% in November. Traders anticipate 73 basis points (bp) of cuts through December 2025. The combination of political uncertainty and monetary policy developments suggests continued volatility in European indices through year-end.

Bank of England