European shares log weekly losses on inflation worries; Volkswagen jumps

European equities experienced a decline throughout the week, ultimately ending lower on Friday. However, Volkswagen's positive performance helped stabilize the market following the company's announcement of a major turnaround plan. The benchmark STOXX 600 index finished the week at 649.88 points, marking a 0.1% increase but an overall decline of 0.8% for the week.

The downturn was driven by the escalation of conflict in the Middle East, which led to higher crude prices and heightened investor concerns over persistent inflation, increasing government debt, and prolonged central bank tightening measures. A strong U.S. non-farm payrolls report also contributed to Friday's market sentiment, signaling stability in the U.S. labor market and reinforcing the expectation of interest rate hikes by the Federal Reserve later in the month.

Investors are now focusing on next week's U.S. consumer inflation data to gain a clearer understanding of the Federal Reserve's rate-tightening trajectory. Fed Chairman Jerome Powell's decision to prioritize inflation over labor market concerns at the Jackson Hole event has been vindicated, and the upcoming inflation report provides the Fed with additional ammunition to tighten monetary policy in September.

Market participants note that the prospect of higher U.S. interest rates has introduced additional pressure on global equities, especially as European economies struggle with sluggish growth and rising energy costs. Late in the trading session, European bourses found support as oil prices eased and positive corporate headlines lifted investor sentiment.

Volkswagen emerged as the top performer for the day, surging 5.9% and reaching a two-month high, surpassing Germany's DAX index. The automaker's lead came after its supervisory board secured a turnaround agreement with unions and shareholders, averting an escalation of protests. Despite the recent gain, Volkswagen's shares are still down 22% this year.

Investors applaud major cost-cutting initiatives, but there is always a risk that companies are cutting too aggressively and leave themselves with insufficient resources if demand increases. The broader European auto index gained 1.1% on the day, buoyed by Volkswagen's performance. Looking ahead to next week, market focus will shift to the European Central Bank's policy meeting, where a 25-basis-point rate hike is widely anticipated.

JPMorgan and BNP Paribas forecast that the European Central Bank will likely raise rates by another 25 basis points in December, as elevated energy prices strengthen the case for further tightening measures.