Euro area activity data in Q1 were weaker than expected, with German industry under pressure. An oil price shock is described as narrower than the 2022 energy shock, with a smaller impact on European activity.
In Germany, industrial production is still falling slightly year on year. A German GDP forecast of 0.1% quarter on quarter for Q1 is maintained, with limited scope for a higher outcome.
Euro Area Fundamentals And Key Supports
Euro area fundamentals are supported by strong private sector balance sheets, investment linked to AI and energy, German fiscal stimulus, and housing markets that are stabilising. The risk of broad second-round wage effects like those seen in 2021–22 is described as lower.
Demographics in many countries may keep labour markets tight. This could lead to earlier upward wage pressure in response to the energy price shock and German fiscal stimulus.
Looking back to early 2025, the market was grappling with weak German industrial figures, which kept a lid on broad European optimism. At the time, we noted the underlying resilience from strong private balance sheets and investment needs in AI and energy. This created a cautious but not outright bearish sentiment for traders.
That cautious optimism proved to be well-founded, as the German fiscal stimulus did indeed help stabilize the industrial sector through the latter half of that year. We’ve now seen German industrial production finally post a 1.2% year-over-year gain as of February 2026, a stark contrast to the declines we were tracking back then. This turnaround suggests the downside risks from that period have largely faded.
Market Positioning And Trading Implications
The concern about wage pressures from a tight labor market was a key point for us in 2025, and it remains relevant today. While headline inflation has cooled to 2.6% according to the latest Eurostat flash estimate, core inflation remains sticky above 3%, driven by services. This divergence keeps the European Central Bank’s future path uncertain, suggesting that options strategies that profit from volatility, like straddles on the Euro STOXX 50, are attractive.
The resilience in private balance sheets has directly translated into stronger-than-expected consumer sentiment, which we see reflected in retail sales figures from France and Spain over the past quarter. Therefore, derivative traders should consider positioning for continued strength in consumer-facing sectors over German heavy industry. Call options on consumer discretionary ETFs could outperform puts on industrial indexes, playing on the same divergence we identified over a year ago.
Given the persistent core inflation and wage tightness, the market may be pricing in an overly optimistic path for ECB rate cuts this year. Looking at Euribor futures, the forward curve suggests at least two more cuts by year-end, which seems aggressive. We believe there is value in using interest rate swaps or selling Euribor futures contracts to position for a more hawkish-than-expected ECB stance in the coming months.
