Strongest rally since 2008 fuels hopes of European bank stocks' revival

By Julien Ponthus and Danilo Masoni

LONDON/MILAN (Reuters) - European bank stocks had their strongest two days since the 2008 financial crisis on Tuesday, as promising vaccine developments prompted their recovery.

Depressed by years of loose monetary policy, the stocks were among the worst losers of the COVID-19 March market crash, at one point losing over 40% of their market value and even lagging the battered travel and leisure index for several months in 2020.

But they have pulled off the biggest recovery on the continent since Pfizer <PFE.N> said its experimental COVID-19 vaccine was over 90% effective. Europe's banking index <.SX7P> was up 16% over two days by 1338 GMT on Tuesday, its best performance since October 2008.

"This is no flash in a pan", said Sylvain Goyon, head of equity strategy at Oddo BHF in Paris. "Banks had reached such low valuation that what's just happened (Pzifer's vaccine) changes the situation".

The deployment of a vaccine and the reopening of the economy means massive provisions set aside by banks to cover potential loan defaults would not need to be increased, a major worry for investors, Goyon said.

Barclays took a similar view, noting that market expectations for loan losses had been higher than what European banks signalled to investors.

"To the extent that the news improves conviction that loan losses will be closer to management guidance it would be a positive driver of estimates", analysts at the UK bank wrote.

Graphic: European banks strongest rally since 2008 - https://fingfx.thomsonreuters.com/gfx/mkt/yzdvxkylwpx/Banks%20best%20rally%20since%202008.GIF

DIVIDEND BET

As cyclical plays, bank stocks are typically first in line to benefit from a rebound in economic growth.

Analysts also believe that by boosting business confidence, a vaccine would reduce the urge for central banks to ease further, which could lift bond yields and alleviate pressure on bank margins.

"We've been having growing interests from our clients ... A key catalyst for banks is the dividend," said Jerome Legras at Axiom Alternative Investments, adding the vaccine news had only triggered appetite further.

Next month, the European Central Bank is expected to review the ban on bank dividends it introduced back in March during the first wave of the Coronavirus pandemic.

The improving backdrop also comes after banks provided one of the biggest surprises during Europe's earnings season, helped by high trading volumes.

On the bearish side, others warn the pandemic could still lead to big loan losses and that the so-called lower-for-longer interest rate environment remains a long-term structural hurdle.

Citi analysts say investors should instead sell into the rally and favour energy stocks over financials when looking for cyclical shares.

"Financials look cheap, but the scope for further increases in nominal bond yields is likely to be limited," they argued.

Graphic: European banks record cheap valuation - https://fingfx.thomsonreuters.com/gfx/mkt/xklvybexdpg/Pasted%20image%201605012661844.png

(Reporting by Danilo Masoni and Julien Ponthus; editing by Larry King)