Will Higher Oil and Rates Derail Europe’s Rally?

Investing.com reports that the recent outperformance of European equities has come to a halt under the weight of climbing crude prices, elevated interest rates, and political turbulence. However, strategists at Barclays contend that the region's fundamental growth picture continues to rest on firm ground.

European shares have gained roughly 10% since the start of the year, a performance not far off that of the United States. Yet the momentum seen in early summer has faded, as strategists led by Emmanuel Cau noted in a research report, citing "renewed pressure from rising energy prices, higher rates, and political noise in France and Germany."

Barclays maintains a neutral allocation stance between European and U.S. equities, observing that the unwinding of momentum trades has for the most part already run its course. A recent bottoming-out among major technology shares has again provided support to American markets.

The bank's economists predict that the European Central Bank will deliver its second rate increase of the year at Thursday's meeting, lifting the policy rate to 2.5%. Unlike conditions in June, the growth backdrop now appears more robust, with nominal GDP growth expected to stay above trend into 2027, led by Germany, the strategists added.

High-frequency indicators are showing continued strengthening, mainly supported by defense-related spending, infrastructure projects, and construction activity. Loan demand earmarked for investment is also climbing, as strategic autonomy initiatives drive a broader capital-expenditure cycle. In the meantime, earnings-per-share revisions for German companies have turned higher from previously depressed levels.

Barclays also flagged that the recent jump in energy prices, tied to the ongoing U.S.-Iran conflict and low gas storage levels, has revived worries about stagflation. The strategists characterized the current shock as "of much lower magnitude than in 2022" and not limited to Europe, yet acknowledged that consumers still face strain from reduced disposable incomes and real wages that have slipped below zero in the euro area.

Robust growth is the principal reason for the ECB to reverse the earlier insurance-style cuts, Cau and his team argued, but they stressed that the surge in energy prices "is unhelpful." They cautioned that any further rise could heighten concerns about the central bank committing a policy mistake.

From a positioning standpoint, Barclays continues to favor capital-expenditure beneficiaries and banks over consumer-facing sectors, while it has withdrawn its underweight stance on communication services. The firm points to strategic autonomy and AI-related capex, alongside German stimulus, as ongoing supports for earnings growth among investment beneficiaries. At the same time, it trimmed its stance on the luxury sector to market-weight, citing elevated oil prices and incrementally softer demand signals from China.

Barclays further states a preference for German equities over French equities, underscoring Germany's stronger fiscal position, improving growth dynamics, and "still undemanding valuations."