The equity markets across Europe kicked off the week on a negative note amid ongoing political turmoil in Germany and France. The German DAX fell 0.45%, the French CAC 40 slumped 0.71%, and the Euro Stoxx 600 index slid 0.12% on Monday.

The two largest European economies face mounting political and economic challenges, alongside US President-elect Donald Trump’s tariff threats. The sell-offs in the European markets may only be a start as the DAX slipped for the second consecutive trading day from its all-time high.

The downbeat sentiment was in contrast to the US stock markets, with the tech-heavy Nasdaq reaching a new high, up 1.24% overnight. The S&P 500 rose 0.38%, while the Dow Jones Industrial average fell 0.25%. 

The political and economic woes in Europe

On the political front, German Chancellor Olaf Scholz lost a confidence vote in parliament, triggering an early Election in February, seven months ahead of schedule. Scholz’s three-party ruling coalition collapsed last month after the Free Democrats Party withdrew amid infighting.

In France, the National Assembly approved a special law to allow the current tax-raising and government borrowings to roll over, temporarily avoiding a US-style government shutdown. However, the country still lacks a full package of the budget plan, leaving the newly appointed Prime Minister Francois Bayrou to face the same challenges that ousted his predecessor, Michel Barnier. 

Furthermore, the economic trajectory points to a further deterioration, particularly in the manufacturing sector. Both Germany and France’s manufacturing Purchasing Manager Indices (PMIs) came in weaker than expected, suggesting that the recession deepened in the sector amid the political instability and weak global demands.

Adding to the pressure, China reported disappointing economic data on Monday, reflecting sluggish consumer demands. European consumer and energy stocks bore the brunt of these concerns, with the Euro Stoxx Luxury 10 Index slumping 0.82% and the Stoxx Europe 600 Energy Index down 0.98%. 

Euro steadies despite the ECB’s hints on further rate cuts

The European Central Bank (ECB) President Christine Lagarde said at the Bank of Lithuania on Monday that the bank will cut the interest rate further “if the incoming data continue to confirm our baseline, the direction of travel is clear”. She noted that the eurozone’s economic growth may “take a hit” under Trump’s protectionist measures, with manufacturers “particularly sensitive to shifts in confidence about world trade”.

The ECB reduced the interest rate by 25 basis points last week, marking the fourth cut of the year. Money markets are currently pricing a more than 90% chance of further cuts on 30 January, just 10 days after Trump’s inauguration. 

Despite Lagarde’s comments, the euro rose slightly against the dollar to 1.0530 at the highest on Monday. However, the single currency retreated against the US dollar, falling to just above 1.05 at 5:21 ECT in the Asian session on Tuesday.

The euro has plunged against the dollar since November amid Trump’s victory in the US election, falling to 1.0330 at a two-year low on 22 November amid an unexpected contraction in the eurozone’s services sector. 

Michael Brown, a senior research strategist believes the EUR/USD pair will go down to test 1.1 before falling further to a parity level, as mentioned several times in his notes.