Euro Slumps on Energy Shock Concerns

The euro retreated to $1.156 by the close of a volatile week, as investors flocked to the US dollar amid deepening inflation fears tied to the Iran conflict’s energy shock. Brent crude surged back to multi-year highs following attacks on Middle East refineries, while reports suggested the Trump administration may target Iran’s Kharg Island. Against this backdrop, traders ramped up bets on ECB tightening, with money markets now pricing in at least two rate hikes in 2026 and a potential third. The central bank held rates steady on Thursday but raised its inflation outlook while cutting growth forecasts, citing escalating risks from the Middle East crisis. ECB policymaker Joachim Nagel signaled a possible rate rise as soon as next month if price pressures persist, while Francois Villeroy de Galhau underscored the bank’s readiness to take decisive action.

The euro bounced back to $1.16 at the end of a volatile week, recovering from an over seven-month low, after the European Central Bank signaled a more aggressive stance on inflation, fueled by surging oil and gas prices tied to the Iran conflict. On Thursday, the ECB held interest rates steady but revised its inflation forecast upward while lowering growth projections for the coming years, citing heightened uncertainty from the Middle East conflict. The central bank’s stance has led major financial institutions to anticipate an interest rate hike as early as April, with markets now fully pricing in a rise by June and assigning a 60% probability to a move in May. ECB policymaker Joachim Nagel emphasized the possibility of a rate increase next month if price pressures continue to build, while Francois Villeroy de Galhau reaffirmed the bank’s commitment to act decisively.

The euro climbed to $1.15 after the European Central Bank left interest rates unchanged for a sixth straight meeting, keeping the deposit rate at 2% as expected. Policymakers signaled a cautious approach, saying decisions will continue to be taken meeting by meeting. The ECB warned that the war in Iran has increased uncertainty, posing upside risks to inflation and downside risks to economic growth, particularly through higher energy prices in the near term. It reiterated its commitment to bringing inflation back to the 2% target over time. Markets still expect further tightening, with two rate hikes fully priced in this year and a possible third. Other major central banks are also holding steady, with the Bank of England and Bank of Japan keeping rates unchanged after the Federal Reserve paused earlier in the week.