The German share price index DAX graph is pictured at the stock exchange in Frankfurt, Germany, February 15, 2022.
The German share price index DAX graph is pictured at the stock exchange in Frankfurt, Germany, February 15, 2022. Reuters / STAFF

European shares slumped 2.7% on Friday after U.S. inflation came in hotter than expected, raising the prospect of a recession as central banks try to put a lid on prices.

Losses on the pan-European STOXX 600 index were broad-based, led by a 4.8% slide in banks. The index extended declines to a fourth straight session, leaving it near the level last seen on May 12 and putting it on course for weekly losses of more than 3%.

Italy's MIB index sank 5.2% to three-month lows. Spain's IBEX gave up 3.7%, while other major bourses in the region lost more than 2% each.

Headline inflation for May in the United State came in at 8.6%, topping an expected 8.3%, suggesting that the Federal Reserve could continue with its 50 basis points interest rate hikes through September to combat inflation. The Fed's take on inflation at its meeting next week will be closely watched.

Equities were hammered on Thursday after the European Central Bank said it would deliver next month its first interest rate hike since 2011, and a potentially larger move in September.

"Markets are in a state of nervousness because the stickiness of inflation essentially forces the central banks to double down on their tightening," said Dhaval Joshi, chief strategist at BCA Research. "The most important question is whether central banks are going to take the economy into recession to conquer inflation."

"Then the sell-off will transform from a valuation sell-off to a profit sell-off."

Euro zone shares fell 3.1% on Friday, lagging the broader STOXX 600 index this week.

Banks, already suffering from heavy losses in peripheral lenders such as those in Italy, accelerated losses on worries about widening spreads between bond yields in Italy and Germany.

"The second reason for banks is that if we're in a stagflation risk, then obviously banks will do badly because of the rising default rates, bad loans and bad debt provisioning," Joshi said.

Concerns also mounted about demand and growth in China, the world's second-largest economy, after Shanghai and Beijing imposed new COVID-19 lockdown restrictions.

Investors pulled out money from European equity funds in the week to Wednesday, marking the 17th consecutive week of outflows, due to uncertainties related to the Russia-Ukraine war, BofA said.

Among individual stocks, GSK rose 1.6% after the drugmaker said its vaccine for respiratory syncytial virus was successful in a late-stage trial involving older adults.

Regional airlines fell as labour strife in Europe drove expectations of more travel headaches during the busy summer season.

Ryanair, International Consolidated Airlines, Lufthansa and Wizz Air dropped between 1.6% and 4.1% .