UK banks Barclays, Lloyds and NatWest could be caught out if the economy takes an unexpected turn, UBS has warned, even as it stays broadly positive on the sector.
The Swiss bank said the three domestic lenders were heavily owned by investors, which leaves them exposed to what it calls "wrong-way" risk should conditions shift and fund managers rush to reshape their portfolios.
The particular danger is higher inflation, which UBS argued the UK market dislikes because of the way it feeds through to deposit costs, echoing the squeeze lenders felt in 2023.
A looming Budget adds to the sense of political risk hanging over the shares in the coming months.
Should stagflation, the toxic mix of stagnant growth and rising prices, prove worse than expected, UBS reckons the two overweight positions would be at risk.
In that scenario, it expects investors to switch out of the UK and into floating-rate markets such as Greece, its top pick, along with Italy, Ireland, Spain and Portugal.
For now, though, UBS is sticking with its exposure to the UK names, judging their earnings growth and valuations attractive enough to justify holding on.
The warning came in a note summing up the mood among big investors after a round of US meetings.
UBS found fund managers comfortably overweight European banks, a stance it shares and thinks is justified.
The case rests on double-digit forecast earnings growth over the next three years, cheap valuations and cyclical tailwinds from loan growth, interest rates and a steeper yield curve.
Even so, investors showed little appetite to add to their positions, wary of the swirl of geopolitical tension, bond market volatility and doubts over the artificial intelligence boom.
What they really want, UBS said, is stock-specific stories to offset a sector otherwise driven by the wider economic backdrop.
Across Europe, the least favoured names are the Nordic banks, held back by slower earnings growth and pricier valuations.
UBS values the sector at about 10 times next year's earnings, a near 30% discount to the wider market.
