What should you do now?

You answered correctly. In this situation, you should slow down to walking pace and remain ready to brake. There are multiple hazards: a cyclist riding ahead, children standing on the sidewalk, and a pedestrian crossing the road. In German traffic rules, when there is a risk of unpredictable movements by children or pedestrians, and a narrow road due to a cyclist, you must reduce your speed drastically and be prepared to stop. Overtaking the cyclist here would be dangerous due to limited space and possible sudden actions from the children or pedestrian. If you follow these rules, you reduce the risk of accidents in such unpredictable situations.