European arms makers retreat as Ukraine peace plan gains traction

(Reuters) -European defence shares fell to their lowest levels since late August on Friday, pausing their strong run this year, after Ukrainian President Volodymyr Zelenskiy said he was ready for "honest" work on a U.S.-backed plan to end the war with Russia.

An index of aerospace and defence companies was down 3.3% at 1004 GMT and heading for its biggest weekly losses since March. It underperformed the Europe-wide STOXX 600 index, which was down 1%.

While off a recent peak in October, the index is still up more than 200% since Russia invaded Ukraine in February 2022.

According to the U.S.-backed plan, seen by Reuters, Kyiv would be required to give up the entire Donbas region and significantly downsize its military, conditions long seen by Ukraine's allies as tantamount to capitulation.

"Even if Europe feels blindsided, (U.S. President Donald) Trump and (Russian President Vladimir) Putin will not care. It could be that the peace plan will actually succeed," said a Frankfurt-based trader.

PROSPECT OF HIGHER DEFENCE SPENDING

Shares in Germany's Renk fell around 11%, on track for a sixth straight day of losses.

Hensoldt, which provides sensor systems for the Eurofighter and Leopard 2 tank-maker Rheinmetall were both down around 7%.

Italy's Leonardo and Sweden's Saab slipped between around 4% and 5%.

Warship builder TKMS also fell around 5%, while Spanish defence and technology firm Indra was down some 4%.

Defence stocks have helped to push the STOXX 600 index 10% higher this year, hitting successive record highs on the back of the prospect of a swell of government spending on regional security.

JPMorgan analysts wrote in a note earlier this week that they saw the latest peace plan as not acceptable to Ukraine or its European allies, and viewed the recent sell-off in defence companies as a "compelling entry point" into the sector.

"If the U.S. is able to impose this plan (which is unlikely, in our view) we think it would amount to a de facto victory for Russia, driving European defence spending even higher than planned and at a much faster pace," they wrote.

(Reporting by Anna Pruchnicka in Gdansk, addditional reporting by Daniela Pegna in Frankfurt, editing by Alun John, Dhara Ranasinghe and Alex Richardson)