US stocks will soon beat European peers again as hotter inflation means the region is heading into more aggressive rate hikes, BlackRock says

• Equities in the euro area have risen more than their US peers for months. "We don't see the outperformance lasting," BlackRock Investment Institute says.
• The market is shifting focus on sticky inflation and the ECB's fight against it.

European monetary policymakers look ready to extend their fight against what their leader calls "monster" inflation, and BlackRock Investment Institute says such action will eventually shut down the outperformance of European stocks over those in the US.

Equities in the euro area have outperformed their US peers by about 14% in local currency terms since the end of September, the research group said in a note published Monday, citing MSCI index data. Europe's ability to withstand an energy crisis stemming from Russia's war against Ukraine has been a key upside driver for the region's stocks. Also playing a role is the reopening of China's economy which bodes well for sectors centered on European exports.

"We don't see the outperformance lasting: The market's focus is shifting to sticky inflation due to firms upping wages to hire and retain staff. Good news on the economy means the European Central Bank (ECB) needs to hike rates more to cool inflation," wrote Wei Li, global chief investment strategist at BlackRock Investment Institute. Euro area annual inflation was tracking at 8.5 % in February year over year, slower than 8.6% in January.

This year in Frankfurt, the DAX equity index has gained nearly 13%, and the CAC 40 in Paris has spiked up 14%. Meanwhile, the S&P 500 has picked up more than 5%.

European companies have been increasing what it pays new workers, and the number of public sector employees has been climbing. That labor market tightness is set to persist, said the research arm of the world's largest asset manager.

"The ECB faces a stark trade-off between pushing up unemployment or living with persistent inflation," wrote Li. "We expect the ECB to raise rates through midyear and not cut them until the second half of 2024." Market pricing indicates rates will peak around 3.9% compared with expectations of 3.2% in February, with fewer rate cuts expected next year.

The ECB has already confirmed it will raise its deposit rate by 50 basis points on March 16, pushing it up to 3%, and signaled more increases are likely. Inflation "is a monster that we need to knock on the head and keep at 2%," ECB President Christine Lagarde said earlier this month.

The ECB in July issued its first rate hike in 11 years with a larger-than-expected increase of 50 basis points for the deposit rate from 0%.

BlackRock said it still expects a recession as higher rates kick in.

"We prefer income from credit and short-term government bonds. We're underweight European stocks but like the financial, energy, healthcare and consumer discretionary sectors," said Li.