European Stocks Lead Again as Stagflation Risks Ease Amid Peace Hopes

European stock markets are set for a notable rally in the second half of 2026, driven by the easing of stagflation risks and the prospect of peace in the Middle East. A preliminary agreement between the United States and Iran has led to expectations of stronger economic growth and a moderation in inflation, enabling European equities to regain their leadership position in global markets.

For some time, tensions in the Middle East had placed significant strain on European economies, primarily due to their reliance on energy imports and inflationary pressures. However, a preliminary peace agreement between the US and Iran, which raised hopes for the reopening of the Strait of Hormuz, has brought substantial relief to markets. Following this agreement, global Brent crude oil prices dropped below $83 per barrel, reaching a three-month low, while wholesale natural gas prices in Europe also saw considerable declines. This development has improved the economic outlook by reducing uncertainty surrounding the region's energy costs.

This positive market sentiment has propelled the pan-European STOXX 600 index to trade near record highs. The index has recouped all its post-conflict losses and is up approximately 7.4% year-to-date. Barclays has consequently raised its year-end target for the STOXX 600 from 620 to 670, citing an improved macroeconomic outlook and reduced stagflation risks, while also closing its 'Underweight' recommendation on European equities. Investors are now rotating into growth-sensitive sectors such as banks, industrial goods, and media stocks, moving away from defensive utilities, telecommunications, and high-flying energy stocks.

The Middle East conflict had created prolonged uncertainty for global supply chains and energy prices. European economies, being particularly vulnerable to energy price shocks, saw this situation influence the European Central Bank's (ECB) monetary policy decisions. The renewed hopes for peace are expected to diminish this geopolitical risk premium, thereby supporting Europe's cyclical and value-oriented sectors. Lower energy costs will reduce business expenses and boost consumer spending power, stimulating overall economic activity.

Analysts anticipate a 12% earnings per share (EPS) growth for Europe in 2026, supported by factors such as Germany's infrastructure plan, more moderate energy costs, and a less unfavorable currency effect. Strategists at J.P. Morgan believe the risk-reward profile for the Eurozone is improving, expecting the region to outperform its peers through the end of the year and beyond. Experts like Ulrich Urbahn from Berenberg suggest that Europe's outperformance could continue as long as markets price in a "peace dividend." However, some investors remain cautious about the lingering impact of previously high energy prices on the economy.