Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / How ECB Rate Hike Is Boosting Southern European Stocks
Transcript
- Lucas: So the ECB hiked rates on Thursday — first time since 2023 — and the immediate reaction in bond markets was exactly what you'd expect. Italian and Spanish yields spiked relative to Germany. But here's the thing I find more interesting: look at equities over the past five days. Luna: You're going to tell me Southern Europe is outperforming, aren't you? Lucas: Exactly. Italy's ETF, EWI, up 3.4 percent in five days. Spain's EWP, up 3.6 percent. Meanwhile, Germany's EWG is basically flat — up 0.4 percent. France's EWQ, up 2.3 percent. So the periphery is crushing the core. Luna: That is not the narrative you usually hear. Higher rates are supposed to hurt the more indebted economies, not help their stocks. Lucas: Right, and that's the conventional wisdom. But think about what drives those markets. Italy and Spain have much heavier weightings in financials — banks that actually benefit from a steeper yield curve. When the ECB hikes, their net interest margins expand immediately. Luna: And German stocks are more industrials and autos, which get squeezed by higher rates and a stronger euro? Lucas: Well, the euro actually weakened a bit — it's at one point fifteen against the dollar, down from one point sixteen before the hike. That's because the market is pricing in more pain for the Eurozone economy from the Iran energy shock. So that's actually a tailwind for exporters in Italy and Spain, which tend to be more mid-cap and niche manufacturing. Luna: And Germany's big exporters — the automakers, the chemical companies — they're facing both higher rates and, you know, actual physical supply chain disruption from the conflict in the Middle East. Lucas: Exactly. So the hike is almost widening an existing split. Southern Europe is more services and tourism and banking; Northern Europe is more industry and energy-intensive manufacturing. The energy shock hits Germany harder. Luna: If walking through the economy with us has made something click — honestly, if today's episode was worth a coffee to you, that's the link. Buy me a coffee dot com slash fexingo. No pressure, just keeps the show independent. Lucas: Yeah, we don't run ads, so listener support is what keeps us going. And it really does help. Okay — back to the equity divergence. Lucas: So the other factor is valuation. Italian and Spanish stocks were already cheap relative to German ones. The MSCI Italy index trades at around nine times forward earnings; Germany is closer to thirteen times. So when rates go up and growth gets uncertain, the cheaper markets have less downside risk baked in. Luna: Add to that the fact that Spain and Italy actually have decent GDP growth this year — real GDP for the Eurozone as a whole grew at 1.6 percent annualised in Q1. That's up from 0.5 percent at the end of last year. So the periphery is growing faster than the core right now. Lucas: That's the key point. The economic data is actually improving for the region as a whole — real GDP hit twenty-four point one five trillion dollars in Q1 — but the composition matters. Service-heavy economies are outperforming manufacturing-heavy ones. Luna: And the ECB's hike doesn't change that fundamental story. If anything, it confirms that the central bank sees the economy as strong enough to handle tighter policy. Lucas: But here's the risk I'm watching: the trade-weighted US dollar index is at 120.1 — that's up from 119.36 a month ago. A stronger dollar and a weaker euro usually helps European exporters, but if the euro keeps falling, it could reignite import inflation, especially energy priced in dollars. Luna: And we already saw wholesale prices in the US rose 1.1 percent in May, more than expected, on a surge in energy. That's going to feed through globally. Lucas: Right. So the ECB is hiking into an energy shock, which is the opposite of what central banks usually do. Normally you'd cut rates during a supply shock to support demand. They're raising because inflation is at 4.2 percent — the highest in three years. Luna: That's a dangerous combination for the bond market. But for equity investors, the distinction between sectors and countries is becoming much more important than the overall market direction. Lucas: Exactly. So if you're looking at European equities right now, you really have to think about the ECB rate path differently depending on which country you're in. The one-size-fits-all narrative is breaking down. Luna: And that's probably going to persist as long as the Iran conflict keeps energy prices elevated and the recovery in services continues to outpace manufacturing. Lucas: Yeah. I'll be watching the PMI data for July to see if the gap starts to close. But for now, the trade is clear: Southern European financials and services over Northern European industrials.