European Banks Increase in Value Expecting Fed Interest Rate Hikes

The logo of Deutsche Bank on a company's office in London, Britain, on July 8, 2019. (Simon Dawson/Reuters)

European bank stocks have been on an upward trend since the third week of December following the announcement by the Federal Reserve regarding interest rate hikes by early spring, indicating better business prospects for financial institutions with higher rates and greater margins.

The Stoxx Europe 600 Banks Index has gone up 9.8 percent in one month and 5.92 percent during the last 5 days, supported by the Fed minutes released recently that showed a keen focus towards hiking rates earlier than expected.

The index touched its highest level since October 2018 outpacing the pan-Euro index which went up 2.35 percent over the month. A coordinated move from the European Central Bank would ensure a significant earnings hike for banks according to analysts.

When the central bank raises interest rates, it typically indicates a strengthening economy where unemployment is low and businesses do not require assistance. Banks have lower numbers of non-performing assets and charge more on loans as credit becomes tighter to acquire. When rates go up, banks don’t necessarily pass on the hike to depositors.

Moreover, the margin between interest amounts paid for savings accounts and the yield from treasuries becomes wider, translating to more profits. Banks in the United States are sitting on lots of cash which they could immediately deploy into investments if there is a change in interest rates.

Barclays went up 3.24 percent to trade at $11.16, the highest level seen since October. BNP Paribas increased 2.25 percent, the highest level for more than three years. HSBC expanded by more than 10 percent over the month, while Deutsche Bank increased in value by over 10 percent from Dec. 31. Swiss multinational investment bank and financial services company UBS boosted its share value by over 26 percent over the past 6 months.

Trading at 8.8 times forward earnings, European bank stocks have low valuations compared to almost 13 times for the U.S. banks. Another reason supporting the stock trajectory is a stable demand for credit throughout Europe.

The spread of Omicron has dampened the economic recovery with renewed staff shortages. However, experts expect this disruption to last only for the first three months of 2022, after which, there will be steady growth in the job market with employers in the United States predicted to add an average of 292,000 new positions monthly in 2022.

A recovery for businesses will be advantageous for banks with increased transactions and lower rates of default. Analysts from the Bank of America, according to Reuters, expect a 23 billion euro ($26 billion) revenue resulting in a 100 basis point upward shift in bond yield curves.