European Stock Rally Stalls on Rising Oil and Rate Hike Fears, Barclays Says

A strong rally in European equities has stalled in recent weeks, pressured by a combination of rising energy prices, the prospect of higher interest rates, and political uncertainty, according to a recent analysis from Barclays.

Rally Loses Momentum

European stocks are up roughly 10% year-to-date, but their outperformance has faded since early summer. Strategists at Barclays, led by Emmanuel Cau, attribute this pause to "renewed pressure from rising energy prices, higher rates, and political noise in France and Germany."

The bank now holds a neutral stance between European and U.S. equities, noting that a recent rebound in large-cap technology stocks has provided renewed support to American markets.

Economic Resilience vs. Headwinds

Despite the challenges, Barclays argues that the underlying economic growth in Europe remains on solid footing. The firm's economists expect nominal GDP growth to remain above its trend into 2027, led by Germany, with high-frequency data showing strength in defense, infrastructure, and construction activity.

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However, the recent spike in energy prices has revived concerns about stagflation. While Barclays notes the shock is "of much lower magnitude than in 2022," it acknowledges the pressure on consumers from lower disposable income and negative real wage growth in the euro area.

ECB Policy and Market Positioning

Barclays expects the European Central Bank (ECB) to deliver another interest rate hike at its upcoming meeting, taking the main policy rate to 2.5%. The strategists see strong growth as the primary reason for the move but warned the energy price spike "is unhelpful" and that further increases could raise concerns about a central bank "policy mistake."

In this environment, Barclays outlined its current investment preferences:

• Favoring: Sectors with capital expenditure (capex) exposure and banks over consumer-facing industries.
• Trimming: Its view on the luxury sector to market-weight, citing higher oil prices and weaker demand signals from China.
• Preferring: German equities over French, pointing to a stronger fiscal position, improving growth, and "still undemanding valuations."