UPDATE 2-Europe's STOXX 600 reverses early gains as Middle East conflict drags on

European shares fell on Thursday after a sharp rebound in the previous session, as the Middle East conflict showed no signs of easing and more tankers came under attack, ‌threatening higher oil prices and a knock-on effect on the global economy. The pan-European STOXX 600 closed 1.3% lower, reversing an earlier gain of as much as 0.6%. The index recorded its strongest session in more than three months on Wednesday.

Export-heavy industrial stocks were the biggest drag on the index, down 2.4%. ‌Siemens Energy fell about 6%, while defence stocks Rolls-Royce and Rheinmetall fell more than 5% each. The broader aerospace and defence index was down 4.2%, ‌in its steepest one-day decline since April. The U.S.-Israel war with Iran entered its sixth day. The U.S. Senate blocked a motion aimed at halting the U.S. air campaign and more Gulf countries were being dragged into the conflict with no end to the disruption to energy infrastructure and shipping in sight.

"It's becoming harder to see a quick resolution ⁠to the conflict ​in the Middle East and ⁠that in turn is forcing markets to look again at their interest rate expectations for the coming months," said Danni Hewson, head of financial analysis at AJ Bell. Banks were down ⁠1.7%, travel and leisure stocks fell 1.8% and miners dropped 3.8% as metal prices eased.

"It's better to take a step back. If we don't have a clear and ​abrupt end to the conflict right now, we will continue to see this volatility extend into the next weeks," said Ipek Ozkardeskaya, ⁠senior analyst at Swissquote Bank. Europe remains heavily reliant on imported oil and LNG, and tighter supply conditions due to the war could push energy and transport costs higher, at a ⁠time ​when growth is already tepid. Three European Central Bank policymakers warned that euro zone inflation would likely rise, and growth sag, if the war sucks in more countries. Morgan Stanley projected the ECB will hold rates steady through 2026, pointing to the inflation risks stemming from the conflict.

Rentokil Initial ⁠jumped 10.7%, the biggest gainer on the STOXX 600, after the pest-control firm reported a 4% rise in annual adjusted pretax profit. German logistics group ⁠DHL dropped 4.6% after reporting a ⁠1.3% decline in fourth-quarter operating profit, weighed down by its freight-forwarding business. Italy's Nexi sank as much as 22% to a record low after Europe's biggest payments group in terms of handled transactions outlined a three-year strategy ‌to cope with mounting sector ‌challenges.