By Craig Mellow

European stocks have been the surprise success story of 2025, and banks the surprise within Europe. The iShares MSCI Europe Financials exchange-traded fund has soared by a third this year, boosted by a 9% jump in the euro versus the dollar. U.S. peers have advanced 5%.

Further gains could be tougher. "The catch-up has happened," says Emmanuel Cau, head of European equity strategy at Barclays Investment Bank. "The market may need some time to adjust now."

But with dozens of bank names on offer in a sector Balkanized by national boundaries, there's still plenty of room for stock-picking.

European financials were a big winner from postpandemic global inflation. It forced the European Central Bank to yank up interest rates after 14 years near zero, which meant banks could at long last earn net interest income. Massive spending promises from Germany's new chancellor, Friedrich Merz, added fuel to the bullish fire this year.

European banks are still not expensive arithmetically. They trade around book value on average, compared with two times in the U.S. Price/earnings ratios are running 40% below other European stocks, says Andrew Stimpson, head of European bank research at Keefe, Bruyette & Woods. Previous rallies have peaked at a 20% discount. "We're still at low multiples," he concludes. "There's definitely more room to go."

The sector's mojo was still working through first-quarter earnings, reported over the past few weeks. Almost 90% of the 38 houses that UBS covers beat profit expectations, reports Jason Napier, head of European banks research.

Shadows loom, however. Europe's economy isn't exactly on fire. Both the European Union and United Kingdom expect gross-domestic-product growth of about 1% this year.

The ECB is loosening again, slashing its key deposit rate from 4% to 2.25% over the past year. A descent to 1.5%, at the low end of market expectations, would "make life a little trickier for the banks," Stimpson says.

Cheaper money should, in theory, spur more borrowing. That's constrained for the moment by President Donald Trump's only recently paused trade wars. The EU is a prime target, racking up a $200 billion-plus goods trade surplus with the U.S. last year and a series of rhetorical insults from the White House. ("The European Union," Trump said, "was formed in order to screw the United States.")

That has left corporate borrowers across the Continent cautious at best, says Johann Scholtz, European bank analyst at Morningstar. "It's hard to see what is going to drive bank earnings from these levels," he says. "None of the banks have lowered guidance to anticipate tariffs."

Scholtz still sees value in one top-10 European bank, BNP-Paribas, whose shares have struggled to recover from a punishing 2024. "Markets saw Paribas as a proxy for shorting France," he says.

He and other investors are mostly combing second-tier names across the financial archipelago. Barclays' Cau is tilting toward the U.K., favoring High Street mainstays Lloyds Banking Group and NatWest Group.

Stimpson is focusing on "some of the most profitable names in the sector, which give defensive qualities." That list includes AIB Group, or Allied Irish Banks; Italy's Intesa Sanpaolo; and Belgium-based KBC Group.

European banks are on solid ground. Nonperforming loan ratios in the euro area have dwindled below 2% from more than 7% a decade ago. "The banks have loads of capital," Stimpson comments. "The missing bit is the growth element."

They can't keep performing like growth stocks without growth forever, though.

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May 15, 2025 01:00 ET (05:00 GMT)

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