Europe sector review – inflation fears could drive interest rates

We’re yet to reach the end of this year’s first quarter, and the global economic backdrop already looks less certain.

Geopolitical tensions, particularly the escalating conflict between the US and Iran, have added volatility to markets and raised fresh questions about the path for inflation and growth.

So, what does this all mean for Europe and our Wealth Shortlist picks?

Related article

Iran conflict - the investment case for doing nothing

Emma Wall

Chief Investment Strategist

This article isn’t personal advice. If you’re not sure an investment is right for you, ask for financial advice. Investments can fall as well as rise in value, so you could get back less than you invest.

What does the Iran war mean for Europe?

The Iran conflict has disrupted energy markets, with concerns over shipping pushing up oil and gas prices. For Europe, which remains reliant on imported energy, higher prices could place renewed pressure on both businesses and households if they persist.

Related article

Energy and geopolitics – plus 4 investment ideas

Joshua Sherrard-Bewhay

ESG Analyst

These developments come at a time when inflation in the Eurozone had already shown signs of ticking up. Annual inflation rose to 1.9% in February, slightly above economists’ expectations and up from 1.7% in January. While still below the European Central Bank’s (ECB) 2% target, the increase highlights how sensitive the outlook still is to energy price movements.

Other price pressures also remain present. Core inflation, which excludes food and energy, rose to 2.4%, while services inflation increased to 3.4%, suggesting domestic price pressures continue in parts of the economy.

A prolonged period of elevated energy prices could push inflation higher and weigh on economic activity across the region, although some economists believe the overall impact may be limited if global energy supply expands. European governments are monitoring the situation closely and considering measures to soften the impact on consumers and businesses if needed.

The European Central Bank (ECB) responded to this by keeping interest rates on hold at 2% for a sixth consecutive meeting but is cautious as energy prices rise. Policymakers warned the recent surge in oil and gas could impact inflation, with forecasts for this year revised up to 2.6%. At the same time, growth expectations have been lowered as higher energy costs weigh on activity.

Looking ahead, the outlook for interest rates has become more uncertain. Markets have shifted to pricing in potential rate increases later this year, although the ECB will only act depending on data. Rates may stay higher for longer if energy-driven inflation persists, but any rises will depend on how the conflict and growth backdrop evolve.

How have European stock markets performed?

Over the past year to the end of February 2026, the broader European stock market, as measured by the MSCI Europe ex UK index, grew 23.01%*. It far surpassed the US, one of the world’s major markets. As always, past performance isn’t a guide to future returns.

Over the year there was a significant difference between ‘growth’ and ‘value’ investment styles. Value is a strategy where investors look to buy shares at a price that’s lower than their true worth or those that are going through a recovery. Growth investors are looking for companies that are expected to experience above-average earnings growth far into the future.

The MSCI Europe ex UK Value index grew 34.19% while the MSCI Europe ex UK Growth index grew 13.24%. In any normal year, returns over 13% are attractive for investors. But the past year has been anything but normal.

Traditional value sectors like mining, banks, and aerospace & defence performed strongly, while growth sectors including technology, healthcare and consumer-related areas failed to keep pace. Mining received a boost from higher commodity prices and demand from the energy transition, while investors’ interest in defence was sparked by the promise of increased government spending amid growing geopolitical tensions.

European smaller companies returned to form over the year, growing 26.86%. When investor sentiment improves it can benefit higher-risk smaller companies that rely more on the strength of their domestic economies for success, which has helped performance.

How have European Wealth Shortlist funds performed?

The European Wealth Shortlist funds have delivered different returns over the past year. We expect this – a range of managers with different strengths, styles and areas of focus will perform differently in different economic conditions.

Remember, past performance isn’t a guide to the future, and the performance here is over a short time. And all investments fall as well as rise in value, so you could get back less than you invest.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest and make sure any new investment forms part of a diversified portfolio.

For more detail on each fund, its charges and specific risks, please see the links to their factsheets and key investor information below.

The Legal & General European Index fund was the best-performing European Wealth Shortlist fund over the past year to the end of February 2026 – over this time the fund grew 23.81%*.

The fund offers broad exposure to larger European companies, excluding the UK. It aims to track the performance of the broader European stock market, as measured by the FTSE World Europe ex UK Index.

The fund has benefited from the broader strength of the European stock market and the low costs involved in running the fund. It performed better than the average European fund this year as market returns were more concentrated than usual in certain countries and sectors, and all passive funds benefited from this.

CT European Select was the weakest-performing fund in the European sector of the Wealth Shortlist, though it still grew 6.82%. The fund’s quality-focused investment approach was a headwind, while value and more economically sensitive sectors performed better.

The fund managers continue to concentrate on the fund’s long-standing investment philosophy and process, which is something we like to see. We expect a focus on quality to provide more stable returns compared with peers when markets are weaker or more volatile.

The managers invest in a relatively concentrated number of companies, meaning each investment could have a big impact on performance, which increases risk.