European indices face pressure from political instability and credit concerns
German political crisis and French credit downgrade weigh on European markets, while traders await UK inflation data and BoE decision.
European indices face pressure from political instability and credit concerns
European markets retreated as political turbulence in major economies and credit rating concerns dampened investor sentiment.
Political upheaval in Germany
Chancellor Olaf Scholz's government collapsed following a successful no-confidence vote on Monday 16 December, triggering early elections for February 23.
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.
According to the European Commission, Germany's economy faces 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 debt-to-GDP ratio stabilising around 63%.
The forecast underscores the current challenges facing the German stock market (DAX 40) but points to potential improvement in the medium-term. Despite these, the DAX 40 hit record highs in mid-December, benefitting from France’s political turmoil.
French economic concerns intensify
European stocks faced additional pressure after Moody's downgraded France's credit rating.
The downgrade raises concerns about higher borrowing costs affecting France's economic recovery as the French 10-year bond yield rallied by 20 basis points to 3.05% following Moody’s downgrade. The French/German OAT/Bund 10-year government bond spread widened to levels last seen in 2012 before normalising.
This development comes amid existing political instability in France, despite a new French prime minister – centrist Francois Bayrou – having been appointed earlier this week by French President Emmanuel Macron.
European stock indices year-to-date comparison chart
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 Survey (PMI) improved to 49.5, still in contraction territory, but rose from 48.3, beating its 48.2 forecast.
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.
UK wage growth beating forecasts may create inflationary pressure, as regular pay in the UK which excludes bonuses increased 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 one 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 of cuts through December 2025.
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The combination of political uncertainty and monetary policy developments suggests continued volatility in European indices through year-end.
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