The headlines today might be focused on ongoing events for Italian banks following Sunday’s referendum result, however the UK banks are making tremendous headway on the UK 100 this morning.

Leading names including RBS (+3.9%), Standard Chartered (+3.8%), Lloyds (+3.5%) and Barclays (+3.2%) are enjoying stellar performances near the top of the index this morning, whilst even HSBC (+3.5%), which was today fined alongside JP Morgan and Credit Agricole for its part in the three banks’ libor rigging collusion, continues to move from strength to strength.

So why is this significant bank rally taking place?

UK bank optimism can be linked back to the negotiations taking place in Italy, where the swift movement of authorities to mitigate fears that Monte dei Paschi di Siena, Italy’s third largest lender, will fail in its plans to to address billions of euros worth of non-performing loans by recapitalising are helping to buoy market sentiment. Reports that the Italian state itself could fund a bailout (perhaps by applying for a €15bn loan from the European Stability Mechanism) have only further calmed investor nerves.

Not only are fears of a European wide banking contagion risk easing, but investors on the continent are also primed for tomorrow’s ECB monetary policy meeting. Whilst talk of tapering its bond buying operations has been mentioned by market commentators since reports circulated in October that it had been raised during ECB talks (which were subsequently rebuked by ECB head Mario Draghi), it is far more likely that tomorrow will in fact result in an extension of the central bank’s QE programme. Expectations for a 6-month extension of its bond purchasing programme from the current March 2017 deadline will help keep monetary policy accomodative for longer – meaning that cheap money will be available to European institutions for a longer period – and will look attractive to UK lenders.

But the reasons for the rally are not just consigned to Europe. The looming US Federal Reserve FOMC meeting next week is also warranting interest from UK lenders. Fed fund futures are predicting a 100% chance of an interest rate hike. Whilst keeping accomodative policy around for longer in Europe may be attractive for those looking to raise capital, raising interest rates in the world’s largest economy indicates that there may finally be a change of course following the biggest financial crisis in recent memory. Not only that, but many banks’ margins will also become much healthier as higher rates of interest can be charged on mortgage repayments. Once the possibility of a tremendous fiscal injection from the Donald Trump administration is factored in, this potential period of increasing economic growth in the US bodes well for some of the UK’s largest companies.

All in all, there’s something for everyone.

Add to the above a final boon for the banks with large foreign operations (BARC, HSBA, STAN) of weakening GBP following an extended bout of strength against both its European and US counterpart, could the conditions for a bank rally be perfect?

Henry Croft, Research Analyst, 7 December