Investing.com – Barclays kept its neutral rating on European banks in a note to clients out Monday and noted that a move by the European Central Bank (ECB) would likely be necessary for the sector’s outperformance to continue.
Although these experts highlighted that share prices have been buoyed by both rising inflation and rate expectations, the explained that they were still waiting to see evidence of this feeding through into the industry-level data.
“The recovery in loan growth continues but remains tepid,” these analysts said.
They added that pressure on lending margins continues to weigh more heavily on the periphery than on the core, U.K. or Nordic banks.
“Our preferred banks in this environment are those where the net interest income outlook is less dependent on the ECB raising rates soon,” they said, highlighting their preference for ABN AMRO Group NV (AS:ABNd), Lloyds (LON:LLOY), DnB (OL:DNB), Societe Generale (PA:SOGN) and Banco Santander (MC:SAN).
As near term headwinds for the European banking sector, Barclays pointed to the possibility that inflation numbers could soften as oil price recovery drops away in April or May and also noted elevated political risk, particularly from the French election in May.
“The combination of these two factors may weigh on the market’s appetite for bank shares in the short-term,” these experts explained.
They suggested that a 20% price-earnings discount for European banks versus the market was in line with history, suggesting that upgrades would be necessary to drive outperformance and that earnings upgrades remain limited.
These analysts noted that the ECB lifting rates could be a catalyst for the sector with the market assigning a 95% that the ECB will raise the deposit rate to minus 0.30% by then end of the fourth quarter in 2018.
“Expectations of a policy shift need to be brought closer for the sector’s outperformance to resume,” they said.
Given the fourth quarter rally, these experts believe that valuations across the sector have converged considerably.
“Our preferred banks are where the margin outlook is less dependent on the ECB raising rates soon; where credit quality concerns appear overstated and/or where the capital position appears comfortable,” they concluded.