Despite UK domestic banks being hit by expectations of lower interest rates in the wake of Donald Trump's 'reciprocal tariffs' announcement, analysts at Keefe, Bruyette & Woods said the sector is still attractive.
Friday was the worst one-day move for the European banking sector in a decade.
Lower interest rates are seen as the main risk to UK bank earnings, with markets anticipating more cuts from the Bank of England as a result of the potential fallout from the new trade levies.
But the broker said current valuations suggest a "dire outcome" despite what they see as a "remarkably benign" banking environment.
The analysts said that US tariffs potentially impact three areas – forex, credit and interest rates – but since Trump's announcement the GBP/USD is broadly flat, the UK economy has "relatively low exposure to US exports" at around 1.5% GDP ("similar to France but around half of Germany/Italy"), and that UK banks have "done little risk-based lending for 15+ years".
Rate expectations for 2025 have only declined by around 0.3%, with a 0.5% move equating to a 5% hit to UK bank earnings. Barclays PLC (LSE:BARC) is an exception, as its earnings would only fall by 2%, KBW estimated.
Supportive for banks, interest rate hedge tailwinds of around 25-40% remain in place for the next two years, and deposit floors only become relevant below 2.5% rates.
Barclays, NatWest most liked
Standard Chartered PLC (LSE:STAN) and HSBC Holdings PLC (LSE:HSBA) shares have seen the weakest weekly performance, down 16% and 13% respectively. Barclays fell 13%, while NatWest Group PLC (LSE:NWG) and Lloyds Banking Group PLC (LSE:LLOY) fell 8% and 10%.
KBW rates Barclays ‘outperform’ with a 380p price target, stating the shares were “too cheap” trading at 5.0 times 2026 forecast earnings and 0.6x book value.
It said Barclays’ relative underperformance reflected US and investment banking exposure, though noted unsecured US lending makes up only 6% of earnings.
NatWest and Lloyds were seen as attractive given their stronger UK lending focus, with KBW continuing to prefer NatWest for its profitability and discounted valuation.
KBW rated NatWest ‘outperform’ with a 550p price target and Lloyds ‘market perform’ with a 75p target.
Lending data remained broadly positive, the broker said, with growth in mortgages, personal unsecured, and corporate lending.
Savings balances slowed in February, though household deposits continued to grow, supported by ISAs and non-interest-bearing accounts.
KBW also noted a benign pricing environment, with mortgage yields rising and deposit rates falling.
Deutsche also supportive on banks
Elsewhere, Deutsche Bank analyst Benjamin Goys said the US tariffs and global recession fears had led to a "significantly negative market reaction" for European banks, as the sector is sensitive to macroeconomic conditions and has this year seen meaningful increases in bank valuations.
Despite the shares falling sharply, the sector is still up this year and has outperformed the wider European market.
"While we acknowledge the high uncertainty right now, we think second order impacts from current market pricing for banks' earnings appear manageable, largely driven by lower revenues," he said.
However, uncertainty could weigh on banks, as in previous crises, he added.
"Considering likely profitability resilience and only modestly lower rates expectations (essentially one additional 25bps cut priced) so far, we stick with our positive view on the sector for now, though (dis)inflation trajectory likely remains the key driver.
"In an optimistic scenario the trade war could even be another case study for the new resilience of the sector, similar to the Ukraine war and the US regional banks / Credit Suisse crisis."