European Stocks Drop as ECB Holds, Oil Surge Fuels Rate Hike Fears

European shares suffered their sharpest decline in more than two weeks on Thursday, dragged lower by a hawkish European Central Bank, a surge in oil prices above $100, and a rout in technology stocks. The pan-European Stoxx 600 index fell 1.3% to 638.5 points, according to Reuters. National benchmarks also declined: Germany’s DAX dropped 1.56%, France’s CAC 40 shed 1.64%, and the UK’s FTSE 100 lost 0.73%.

The selloff came as the ECB held its benchmark deposit rate at 2.25%, as expected, but opened the door to another increase at its September meeting. ECB President Christine Lagarde told a news conference that the full effects of the energy shock from the Middle East conflict have yet to play out, and that the bank stands ready to adjust all of its interest rates to ensure inflation returns to its 2% medium-term target. “Renewed disruption of energy supplies could increase energy prices further and for longer than expected,” Lagarde said, as reported by CNBC.

Markets interpreted Lagarde’s comments as leaning toward a September hike. “The ECB is clearly leaning hawkish. For all the data it will see and the analysis it will conduct between now and September, the decision will, to a large extent, come down to the trajectory of oil prices and conditions in the Middle East,” said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, in a Reuters report. ING economist Carsten Brzeski, quoted by Daily Sabah, said, “The European Central Bank has again turned more hawkish, suggesting that a September rate hike is almost a done deal.” Ed Hutchings, head of developed market rates at Aviva Investors, told CNBC that traders now expect a 0.25% hike in September.

The ECB’s hawkish tone was driven by renewed conflict in the Middle East and the resulting spike in energy prices. Brent crude futures hit $100 a barrel on Thursday for the first time since May, after Yemen’s Houthis said they had attacked two Saudi oil tankers in the Red Sea, according to Reuters. One source reported Brent rising to $101.22 a barrel, gaining more than 7%. The surge in oil lifted European energy shares 1.54%, Reuters reported. TotalEnergies gained 2.5% after reporting its strongest quarterly earnings in nearly three years, boosted by higher oil prices and robust refining margins.

The rise in oil and bond yields weighed broadly on equities. U.S. and European bond yields rose sharply: two-year German yields hit their highest in two years, and U.S. two- and 10-year yields reached 18-month highs, according to Reuters and Channel News Asia. The yield move reflected growing expectations of tighter monetary policy. Rates traders are now pricing in 60 basis points of Federal Reserve hikes by April, Channel News Asia reported.

Technology stocks were the hardest hit, with the sector sliding 2.9% in Europe, Reuters reported. STMicroelectronics plunged 17.7% after the chipmaker forecast third-quarter revenue slightly below market expectations. BE Semiconductor dropped 7.3% after its second-quarter results. Infineon fell more than 6% in Germany. The tech selloff echoed weakness in U.S. Big Tech, where Alphabet and Tesla reported disappointing results, with Alphabet’s free cash flow turning negative for the first time since its listing and Tesla’s free cash flow turning negative for the first time in two years, as reported by Channel News Asia. “You’re seeing more questions being asked about where’s the future revenue going to come from,” said Rushabh Amin, multi-asset portfolio manager at Allspring Global Investments, quoted by Reuters. “Even if you have decent earnings, there is a kind of drag coming from a slight unwind in sentiment and in positioning.”

The food and beverage index fell 4.1%, dragged down by Nestle, whose shares tumbled nearly 8% — their biggest loss since 1989 — after the company said it would sell part of its water and premium beverages business to Platinum Equity, Reuters reported.

Other notable movers: easyJet rose 2.7% despite a 70% drop in third-quarter profit, as the budget carrier flagged strong summer demand. Finnish forestry group Stora Enso fell about 8.5% after reporting quarterly operating profit below market expectations. Daimler Truck Holding rallied nearly 4% after raising its full-year revenue and profit outlook, according to a Nasdaq report.

The ECB, in its statement, assessed that energy prices remain volatile and elevated compared to pre-war conditions, noting that “uncertainty remains high and the full inflationary impact of the energy shock has yet to play out,” as reported by The American Conservative. Eurozone inflation eased to 2.8% in June from 3.2% in May, but remains above the ECB’s 2% target. Lagarde said she does not expect inflation to return to target until the first half of 2027, according to CNBC.

The combination of rising yields, elevated oil prices, and the prospect of further rate tightening is likely to keep pressure on European equities in the near term.