Euro Slightly Up on ECB-Fed Policy Divergence

The euro strengthened in early April, climbing to $1.16 and distancing itself from the seven-month lows recorded in mid-March, following US President Donald Trump’s statement that the US could withdraw from Iran within "two or three weeks," regardless of whether a deal with Tehran is reached. The rebound came after a turbulent March, during which the euro lost 2.2% against the USD, its worst monthly performance since July 2025, amid escalating Middle East tensions. However, the Strait of Hormuz crisis remains unresolved, with the effective closure of the critical waterway continuing to disrupt oil supplies and drive prices upward. Ongoing uncertainty and rising inflation concerns have prompted markets to reassess expectations for the European Central Bank’s policy path. Investors now anticipate two interest rate hikes in 2026, down from projections of three hikes earlier this week. Before the war, investors had anticipated no hikes in 2026, with a slight chance of monetary easing.

The euro closed March at $1.15, nearing its lowest point in nearly two weeks, after a volatile month marked by escalating tensions in the Middle East. The common currency lost over 2% against the dollar as traders assessed the economic impact of the deepening conflict. Adding to the uncertainty, a Wall Street Journal report revealed that US President Donald Trump had signaled a potential end to the US military campaign against Iran, even if the critical Strait of Hormuz remained largely blocked. Soaring oil prices fueled inflation across Europe, prompting markets to drastically revise their expectations for the European Central Bank’s policy. Investors now anticipate at least two interest rate hikes in 2026, abandoning earlier forecasts of a 40% chance of a rate cut. While French central bank chief François Villeroy de Galhau reaffirmed the ECB’s commitment to curbing energy-driven inflation, he cautioned that it was “too early” to specify the timing of any rate adjustments.

The euro slipped to $1.15 by the end of March, flirting with its weakest level since mid-March and heading for a monthly drop of over 2% against the dollar. Risk aversion intensified as traders weighed the economic fallout from the worsening Middle East conflict, with reports of US troop preparations for a possible ground operation eclipsing Washington’s claims of progress in Iran talks. Economic data added to the pressure: German CPI pointed to rising inflation in Europe’s largest economy, while the Eurozone business survey showed a steep decline in sentiment as inflation expectations spiked. Markets have radically repriced ECB policy, now anticipating at least two rate hikes in 2026, and potentially a third, ditching earlier expectations of a 40% chance of a cut. Meanwhile, French central bank chief François Villeroy de Galhau stressed the ECB’s resolve to contain energy-driven inflation, though he cautioned it was “too early” to discuss specific timing for rate increases.