Euro Slips Below $1.18 Amid Middle East Tensions

The euro traded just below $1.18 on Tuesday, retreating from last week’s three-week highs, as investors focused on escalating Middle East tensions and the European Central Bank’s cautious stance. US President Donald Trump confirmed that the two-week ceasefire between Washington and Tehran will expire on Wednesday evening, while US Vice President JD Vance and an Iranian delegation are set to arrive in Pakistan later today for peace talks. Ahead of the ECB’s upcoming monetary policy decision, where no rate changes are expected, President Christine Lagarde warned that the Eurozone’s economic outlook “remains deeply uncertain.” Lagarde warned that the Middle East conflict, including the Strait of Hormuz blockade, has disrupted Europe’s energy security, calling the supply shock “enormous.” While energy prices haven’t yet triggered the ECB’s worst-case scenario, she stressed the outlook remains fragile.

The euro was little changed around $1.18, trading only slightly below the pre-conflict levels reached last week, as markets absorbed fresh setbacks in negotiations between the US and Iran. Tensions escalated over the weekend after the US Navy fired upon and boarded an Iranian-flagged cargo ship. This reversal came swiftly: on Friday, Iran’s foreign minister had stated the strait would remain fully open to commercial traffic during the 10-day ceasefire between Israel and Lebanon. Also, there is no clarity on whether US and Iranian officials will meet ahead of the expiry of the 14-day ceasefire between the two countries on Tuesday. Meanwhile, the ECB is set to decide later this month, with no changes in borrowing costs expected at this meeting. Instead, focus remains on the June meeting, although the evolving situation in the Middle East could alter the outlook. On Friday, the IMF said it expects the ECB to raise rates by around 50bps in 2026 to maintain a neutral policy stance.

The euro strengthened above $1.18, reaching its highest level since before the conflict with Iran began, supported by broad dollar weakness as investors welcomed news of the temporary reopening of the Strait of Hormuz, which helped ease near-term inflation concerns. Iran’s foreign minister confirmed that the strait is fully open to all commercial vessels for the duration of the 10-day ceasefire. In response, oil prices tumbled more than 10%, alleviating some pressure on inflation. The euro is up 2.7% on the week, its biggest gain in a year, and is on track for a third consecutive weekly advance, as traders increasingly bet the ECB may raise interest rates this year. Earlier in the week, ECB President Lagarde acknowledged that elevated energy costs have pushed the eurozone away from its baseline economic path, but she refrained from signaling any imminent rate increases.