European shares edged higher Friday, with a blowout earnings report from software giant SAP powering the region's technology sector, even as investors continued weighing an escalating Middle East conflict, fresh U.S. tariffs, and the prospect of further European Central Bank tightening.

The Numbers

The pan-European STOXX 600 index edged 0.6% higher to 644.67, rising for the second straight week. Germany's DAX rose as SAP gained 10% after the software group reported second-quarter current cloud backlog growth ahead of analyst expectations. The broader technology index added 1.7%, reclaiming some lost ground after quarterly updates from STMicroelectronics and BE Semiconductor had failed to impress investors on Thursday. The STOXX 600 technology sector is now up nearly 17% for the year, trailing only the energy sector.

The AI Valuation Debate Continues

Even with Friday's rebound, strategists remain split on how sustainable the sector's rally really is. Investors have been trying to balance AI-driven growth against stretched valuations and returns from hefty technology investments, a tension that's led to repeated swings in share prices across the sector. Deutsche Bank analysts led by Jim Reid summarized the core concern bluntly: "The two big problems for the big tech companies are that capex is no longer being funded out of free cash flow alone and that cheaper open-source AI is seriously threatening business models."

The ECB's Rate Path Remains Live

The European Central Bank may need to raise interest rates again given elevated inflation risks, three policymakers said Friday, a day after the bank left rates unchanged but kept a September hike on the table. Markets are currently pricing in a 25-basis-point increase and roughly a 70% chance of another similar hike by the end of 2026, according to LSEG-compiled data. Encouragingly for the broader growth outlook, survey data showed Eurozone business activity returned to expansion in July for the first time in four months, driven by a resurgence in new orders.

Fresh US Tariffs Add to the Mix

The U.S. administration imposed new tariffs of 10% and 12.5% on goods from 60 trading partners over allegations of lax enforcement of forced labour bans, just as a temporary 10% global tariff expired, adding another layer of policy uncertainty for European exporters.

Individual Movers

Volkswagen dipped about 1% after the automaker dropped its previous revenue growth forecast following a 9.5% slump in second-quarter profit, while Valmet soared 22% and was on track for its biggest one-day jump on record following strong results from the pulp and paper equipment maker.

Middle East Tensions Still in the Background

Despite the tech-driven optimism, the ongoing U.S.-Iran conflict remains a persistent undercurrent for European markets, with investors continuing to monitor developments in the Gulf and their potential spillover into oil prices, inflation, and the broader rate outlook.

What's Next

With SAP's strong cloud results offering a rare bright spot amid an otherwise mixed earnings season for European tech, and the ECB explicitly keeping a September hike on the table, investors will be watching closely for further earnings updates, incoming inflation data, and any fresh developments in the Middle East conflict as the key variables shaping European markets heading into the back half of the summer.