What should you do now?

You answered correctly. In situations where the road is very narrow due to parked cars on both sides and another vehicle is approaching or pulling out, German traffic law requires you to slow down and be ready to brake. This aligns with the principle of defensive driving and mutual consideration (§1 StVO). Maintaining your usual speed or swerving to the left would both be dangerous, as the space is limited and unpredictable hazards may appear. Always reduce your speed in tight situations to ensure there's enough space and time to react safely. This approach helps avoid accidents and is expected on narrow city roads.