Minutes from the European Central Bank’s April policy meeting showed policymakers judged upside risks to inflation and downside risks to growth to have intensified, with members warning that weakness could persist well beyond the end of the conflict. They judged the current episode to be a classical negative supply shock, distinct from the situation in 2022. The energy price shock was described as not only large but increasingly persistent, with a risk of feeding into broader inflation dynamics, while more information on its impact was expected by June.
At the same time, the accounts said there was little evidence that higher energy prices were generating second-round effects, and that it was too early to see such effects on the consumer side because wage negotiations would need to occur first. Some members said they would not have opposed raising rates, and others argued it was increasingly unlikely that a “looking through” approach without monetary policy action would remain appropriate, with the decision characterised as a close call. The minutes also recorded arguments that risks of unanchoring had re-emerged; a definitive agreement to end the war was not expected to deliver a quick reversal in inflation risks. In markets, EUR/USD was slightly above 1.1600, down 0.12% on the day.
ECB Policy Challenges and Market Implications
We see that policymakers are acknowledging that inflation risks are becoming more persistent, raising the chance of it feeding into broader price dynamics. Recent flash data for May showed Eurozone inflation remains sticky at 3.1%, well above the central bank’s target. With negotiated wage growth also coming in at 4.2% for the first quarter of 2026, the risk of second-round effects is now a clear concern.
This suggests we should position for higher short-term interest rates, as it is increasingly unlikely that the European Central Bank can maintain its current stance. Looking at the 2022-2023 hiking cycle, we saw that once the consensus shifted, policy action followed decisively. Therefore, paying fixed on short-term interest rate swaps or selling Euribor futures for the upcoming quarters could prove profitable.
Opportunities in FX and Volatility Markets
The potential for a rate hike also creates opportunities in currency markets, especially as other central banks may be on hold. We believe buying EUR/USD call options is a prudent strategy to gain exposure to a stronger Euro while limiting downside risk. With the pair currently trading around 1.0950, targeting strikes above 1.1100 for the third quarter seems reasonable.
Given that a number of members have previously argued for tighter policy, any upcoming decision is likely a “close call,” which points to heightened market volatility. The Euro STOXX 50 Volatility Index (VSTOXX) is trading at a relatively low 14, making options an inexpensive way to trade this uncertainty. We see value in buying straddles on the Euro currency or major European equity indices ahead of the June policy meeting.
