EU Economy: Weekly Commentary – May 11, 2026

European Market Review

Eurozone yields fell, spreads remained wide, equities mixed, euro strengthened, and Brent crude dropped sharply on easing US–Iran tensions, reducing supply disruption fears and risk premiums.

Last week, Eurozone sovereign bond yields broadly declined, with the 10-year spread between Germany and France at 62.4 basis points and the spread versus Italy remaining above 75 basis points. Equity performance across the region was mixed, as Portugal fell sharply by 2.97% while Italy and Belgium both rose by more than 2%. The euro strengthened by 0.55% against the US dollar. In commodities, Brent crude declined by 6.36% amid easing geopolitical tensions following reports of progress in US–Iran negotiations toward a potential agreement, which reduced concerns over supply disruptions in the Middle East, particularly around key routes such as the Strait of Hormuz, and led to a sharp unwinding of risk premiums despite ongoing inventory drawdowns.

Europe View Synopsis

Euro area activity contracted in April as services weakened, demand fell, and inflation rose. Germany’s industry remained a key drag, with weak output and stockpiling-driven orders.

The euro area economy contracted in April, with the Composite PMI falling to 48.8 from 50.7, signalling the first overall decline in private sector activity in nearly 18 months. The deterioration was driven mainly by a sharp contraction in services, which recorded its steepest decline in over five years, while manufacturing remained mildly resilient but increasingly reliant on inventory accumulation rather than genuine demand. Across member states, activity weakened broadly, with Germany, France, and Spain all contracting, while only Italy and Ireland continued to expand. Demand conditions softened further as new orders fell for a second consecutive month at the fastest pace since late 2024, and business confidence dropped to a 31-month low amid geopolitical uncertainty linked to the Middle East conflict. Inflationary pressures intensified, with input costs rising at the fastest rate in over three years and firms passing these increases to output prices, reinforcing stagflation risks. Employment declined modestly and backlogs fell sharply, signalling weaker future activity. Within this context, Germany’s industrial sector remains a key drag, with output contracting due to weak exports, high energy costs, and supply chain risks, while recent order gains appear driven mainly by precautionary stockpiling rather than sustained demand recovery.

Business Activity

Eurozone economy contracted in April. Services slumped, demand weakened, and confidence fell. Rising input costs drove fastest price increases in three years, signalling growing stagflation risks.

The euro area economy returned to contraction in April for the first time in nearly 18 months, with the Composite PMI Output Index falling to 48.8 from 50.7 in March, dropping below the 50 no-change threshold and marking its weakest reading since November 2024. The data point to a modest but broad-based decline in private sector activity at the start of the second quarter, driven primarily by a sharp deterioration in the services sector, where activity fell at the fastest pace in over five years. This weakness more than offset a still-resilient manufacturing sector, where output growth was supported in part by inventory building rather than underlying demand. Economic performance diverged across member states, with Germany, France and Spain all recording contractions, Germany and France at the steepest rates in over a year, and Spain at its sharpest since August 2023, while Italy and Ireland continued to expand. Demand conditions weakened further, with new business declining for a second consecutive month at the fastest pace since late 2024, and business confidence dropping to a 31-month low amid ongoing geopolitical uncertainty linked to the war in the Middle East. At the same time, inflationary pressures intensified significantly, with input costs rising at the fastest rate in more than three years, prompting firms to raise output prices at the sharpest pace over the same period, reinforcing signs of a stagflationary backdrop. Labour market conditions softened, with overall employment edging lower due to manufacturing job losses, while services employment remained broadly stable, and firms reduced backlogs of work at the quickest rate since May 2025, highlighting weakening pipelines of future activity.

We expect that the Eurozone economy will stay weak in the near term as soft demand and high inflation continue to weigh on growth, with stagflation risks still elevated.

German Industrial Sector

Germany’s industry weakened. Middle East tensions, rising energy costs, slowing exports, and supply chain risks hurt production. Stronger industrial orders likely reflected precautionary stockpiling.

Germany’s industrial sector deteriorated further as the conflict in the Middle East and rising energy prices added pressure to an already fragile economy. Industrial production fell 0.7% MoM in March, marking the fourth consecutive month without growth, while first-quarter output was more than 1% below the final quarter of 2025. Manufacturing was the main drag, although construction activity showed modest improvement. Export growth also slowed sharply to 0.5% MoM, while imports surged more than 5% MoM, narrowing Germany’s trade surplus to its lowest level since November. Although Germany initially reported stronger-than-expected first-quarter GDP growth of 0.3% QoQ, the latest industrial data has increased the likelihood of a downward revision. The outlook for German industry has worsened significantly as the country remains highly exposed to energy imports and vulnerable to supply chain disruptions linked to tensions around the Strait of Hormuz. Energy-intensive industries, which account for around 17% of industrial gross value added and employ nearly one million people, face mounting risks from soaring costs and logistical bottlenecks. Additional concerns stem from potential new U.S. tariffs on European automotive exports, which would further strain the sector. While German industrial orders unexpectedly rose 5.0% MoM in March, well above forecasts, economists caution that the increase may reflect companies stockpiling inventories and accelerating purchases ahead of anticipated supply disruptions and higher prices rather than a genuine recovery in demand. Business sentiment indicators and manufacturing surveys already point to weakening confidence, with analysts expecting industrial activity and orders to decline in the second quarter despite temporarily stronger order books.

We expect continued weakness in German industry as the Middle East conflict, elevated energy prices, and ongoing supply chain risks continue to weigh on production, exports, and business confidence.