This year, European bank stocks have surged 34%, reaching their highest level since 2008!

Once regarded as the "forgotten child" of the market, the European banking sector is now experiencing a long-awaited moment in the spotlight.

Thanks to the surge in long-term interest rates and an improved economic outlook, major European bank stocks have climbed to their highest levels since the 2008 global financial crisis.

The latest market dynamics confirm this trend. This week, several large European banks' stock prices reached multi-year highs. Among them, HSBC's stock price, listed in London, hit an all-time high, while Barclays and Santander's stock prices also reached peaks not seen since 2008, and UniCredit's stock price rose to its highest level since 2011.

This strong rebound has driven the European Stoxx 600 Bank Index up 34% year-to-date, outperforming its American counterparts and is expected to achieve its best annual performance since 2009.

The European banking sector is undergoing a transformation from "market outcast to darling," said Justin Bisseker, a European banking analyst at Schroders.

According to the latest report from the Financial Times, for more than a decade after the financial crisis, European banks were criticized for their lack of capital and were forced to continuously bolster their capital buffers under regulatory requirements, which limited shareholder returns. At the same time, the near-zero interest rate environment made it difficult for them to be profitable.

Now, higher interest rates, a favorable macro environment, and banks' own efficiency measures have collectively boosted the entire industry. In the wake of the pandemic, central banks around the world have raised interest rates to combat inflation. This has significantly increased banks' net interest income—the difference between loan yields and deposit costs—becoming a key driver of profitability.

For example, it has been reported that the yield on Germany's 30-year government bonds is currently 1.3 percentage points higher than that of the 2-year bonds, while in the UK, this spread exceeds 1.5 percentage points, creating an excellent profit environment for banks.

Valuation Gap Still Attractive

Despite the significant rise in stock prices, many investors believe European bank stocks remain "cheap." Luca Paolini, chief strategist at Pictet Asset Management, pointed out that bank stocks are "undervalued and are in a unique advantageous position in an environment of recovering domestic demand."

According to FactSet data, many European banks' valuations have only recently returned to their book values, while their American counterpart JPMorgan has a price-to-book ratio of about 2.4 times. Additionally, Bloomberg data shows that European banks' expected price-to-earnings ratio is about 10 times, lower than their American counterparts' over 13 times. Meanwhile, as a key indicator of bank profitability, many European banks' return on tangible equity (ROTE) has now steadily exceeded 10%.

The Road Ahead Is Not Smooth

However, whether this feast can continue remains uncertain. The market is beginning to question whether the upward momentum of the European banking sector can be sustained without the continued rise of long-term interest rates. Francesco Sandrini, head of global multi-asset strategy at Amundi, believes that "banks seem to be the best choice right now," but "more and more people feel that the best times may have already passed." In addition, hopes for industry consolidation have repeatedly been thwarted. For example, Banco Bilbao Vizcaya Argentaria (BBVA)'s acquisition proposal for Banco Sabadell and the potential interest of UniCredit in BPM both face political resistance, which is seen as limiting the growth potential of the industry.

Nevertheless, Schroders' Bisseker added, "The good news is that, compared to the banking sector in other parts of the world, European banks are still undervalued, and further valuation convergence is likely to occur in the future."