Will banks continue their strong run in 2026?
Banking stocks are on a roll but will the re-rating continue in 2026? A City firm has backed UK lenders to shine, with one name in particular set to thrive.
18th December 2025 13:28
by Graeme Evans from interactive investor
UK banks have been backed to outperform European peers after a City firm named Barclays (LSE:BARC) as one of its top picks and forecast further upside for Lloyds Banking Group (LSE:LLOY) and NatWest Group (LSE:NWG).
Morgan Stanley’s 2026 forecast takes a positive stance on the wider European sector, which it regards as inexpensive and ripe for a re-rating thanks in part to the support of wealth management and investment banking fees.
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However, the boost of ongoing structural hedge tailwinds, good volume growth and strong capital generation means it expects UK banks to outperform in 2026.
Barclays replaces Lloyds as one of its European top picks, having seen the latter’s shares jump by more than 70% to 96p during 2025.
Morgan Stanley said: “We remain positive on Lloyds but see more re-rating potential in the next three-six months at Barclays as we look forward to its strategic update on 10 February.”
The presentation alongside annual results will feature new financial and operational targets for the period up to 2028, including the key industry benchmark of return on tangible equity (RoTE).
The metric, which is post-tax profit divided by tangible equity, has improved to 12.3% in the year to date and is forecast under Morgan Stanley’s base case to reach 13.9% in 2028. However, it sees room for Barclays to increase the RoTE to closer to 15%.
Morgan Stanley’s base case points to £12 billion of share buybacks in the next three financial years, which with dividends would mean a total yield of over 30% by the end of the plan.
The target on Barclays shares is 510p compared with today’s price of 460.7p, but with successful reinvestment it believes the figure could be driven closer to 600p.
The view of Barclays as one of its top picks follows similar moves by counterparts at UBS and Deutsche Bank. The former flagged the revenue growth potential in investment banking, which has been one area where the City is positioned more cautiously than management.
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The Morgan Stanley report estimates that UK banks will deliver net interest income growth of 10% in 2026, double the rate of European peers, and followed by more progress in 2027 and 2028. It forecasts UK lenders will yield dividend income of 4% per year.
On the other UK banks, Morgan Stanley has backed Lloyds shares to reach 110p and NatWest to move from today’s 634p to 720p. Standard Chartered (LSE:STAN) is seen reaching 1,848p, while the bank did not publish a target price for HSBC Holdings (LSE:HSBA).
The European sector as a whole is valued at 9.5 times forecast 2026 earnings, a 37% discount to the wider market. This narrows to 21% under the bank’s forecast valuation of 11.4 times.
That is higher than the 10.4x average of the last 40 years. However, it believes that this is reasonable when set against years of recession, negative rates and the fact the sector is back to pre-financial crisis levels of profitability.
Banks in the 2000-06 period traded at an average price/earnings multiple of 11.4 times with average earnings per share (EPS) growth of 12% and an annual dividend yield of 3.5%.
Morgan Stanley said: “Our forecasts today point to a similar EPS growth of 12% but more capital generation with a 5-6% dividend yield.
“There are several levers driving growth, excess capital and return on tangible equity at 16-17%, which makes the earnings outlook more predictable.”
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Morgan Stanley’s valuation would leave European banks trading at a 15% discount to their US peers, versus the current position of 28%.
It said the improvement in economic activity indicators since the summer pointed to an acceleration of loan growth in 2026, which combined with wealth and investment banking progress should help the sector to re-rate further.
The bank expects a step-up in merger and acquisition activity, noting that deal synergies have the potential to produce a higher return on investment than share buybacks.
Alongside Barclays, its other top picks are Banco Santander SA (LSE:BNC), Societe Generale SA (EURONEXT:GLE) and ING Groep NV (EURONEXT:INGA).
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