The euro zone’s first-quarter GDP was revised into contraction at -0.2% quarter-on-quarter, largely due to Ireland, where GDP was cut to -12.1% qoq. Ex-Ireland growth was 0.3% qoq, alongside firmer PMI readings and stronger French industrial data, shifting the focus away from a broad-based slowdown. While sentiment weakness remains concentrated in Germany and France, the latest French hard data moved in a more supportive direction.
In France, the risk of a second consecutive quarterly decline in GDP in the second quarter has receded. On prices, headline inflation printed at 3.2% year-on-year in May, and underlying inflation was 2.5% yoy. Projections point to peaks in early 2027, with headline inflation seen around 3.8% yoy and core inflation around 2.8% yoy.
Misinterpretation of Euro Area Growth and Resilience
We believe the market is misinterpreting the recent negative GDP report for the Euro area. The headline figure was dragged down almost entirely by a volatile, one-off revision in Ireland, and this statistical noise hides the underlying stability of the wider European economy. Excluding Ireland, the Eurozone actually grew, which suggests the narrative of a deepening slowdown is misplaced.
The latest economic indicators support a more optimistic view than the GDP print suggests. For example, the S&P Global Eurozone Composite PMI for May recently came in at 52.6, well into expansion territory and indicating the strongest private sector growth in a year. This aligns with stronger industrial data out of France, reducing the chances of a technical recession there and suggesting economic resilience.
Interest Rate Market Implications and Strategy
This data disconnect creates an opportunity in interest rate markets ahead of the next ECB meeting. Current market pricing seems to be assigning a lower probability of future rate hikes due to recession fears, which we see as unfounded. With Eurostat’s latest flash estimate showing inflation holding firm at 3.3% in May, the ECB’s focus will remain on tackling price pressures.
Our own projections show inflation won’t peak until early 2027, meaning the central bank’s job is far from over. This historical persistence in inflation, seen during other post-crisis periods, suggests the ECB will need to maintain a hawkish stance for longer than many anticipate. Therefore, derivative markets appear to be underpricing the forward path for European interest rates.
Given this view, we see value in positioning for higher short-term rates than the market currently expects. Options that profit from a rise in EURIBOR or swaps that bet against a dovish ECB pivot in the coming weeks look attractive. We anticipate a repricing of rate expectations as the market looks past the Irish GDP distortion and focuses on the more resilient core data.
