November 17, 2016 / 1:40 PM / 3 years ago

GRAPHIC-Reflation trade underpins European financials outperformance

* European financials rel performance:

* European financials vs bond yields:

* Concerns around costs, bad loans remain

LONDON, Nov 17 (Reuters) - European financial stocks are enjoying their best week-long run relative to the broader market since early 2012 as the beaten-down sector rides the coattails of renewed investor interest in financials globally on the back of rising bond yields.

The so-called “reflation” trade - bets that inflation in major economies globally is edging higher - was further bolstered by Donald Trump’s shock win in last week’s U.S. presidential election, and has sparked a bond sell off while brightening the outlook for growth-sensitive sectors such as banks and industrial companies.

European financials, particularly banks, were among the worst performing sectors until last month, bogged down by slumping investment income, high regulatory costs and a sluggish regional economy.

Banks are up nearly 6 percent since the day before the U.S. election, compared with a 1 percent rise for the STOXX 600. European insurers are up almost 4 percent.

Financials' share prices correlate closely with government bond yields, which are important factors for net interest margins and profitability.

Banks have overtaken telecoms, utilities and healthcare on the year-to-date sector performance tables, underscoring the shift away from dividend-yielding stocks to sectors more geared to economic growth.

However, the rally comes even as several European banks continue to grapple with bad loans, high costs and a slew of political risks on the horizon in Europe, including a referendum in Italy next month and French elections next May.

Mark Burgess, the chief investment officer EMEA at Columbia Threadneedle, said the outlook on financials was one of the biggest questions for the firm going into 2017, adding he was taking a cautious view.

“The rally in European banking shares has probably run its course,” Burgess told the Reuters Investment Summit in London.

Reporting by Vikram Subhedar; Editing by Mark Potter

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