Eurozone markets are being priced for a stagflationary shock linked to US-Iran tensions, with Europe expected to feel more of the impact than the US. That backdrop is seen pushing the European Central Bank towards earlier tightening, with a 25 bps increase in the deposit rate pencilled in for the 11 June meeting, taking it to 2.25%. Guidance is expected to remain cautious while retaining a hawkish tilt, and policy is framed as meeting-to-meeting.
Further rate rises are viewed as possible in 2H, conditional on developments such as a ceasefire and any easing in tensions. On the macro side, the 2026 growth forecast is reduced to 1.0% from 1.4%, alongside higher annual inflation projections. The discussion also references a baseline assumption of $90pb oil and EUR50 per MWh gas in 2Q26, before prices moderate thereafter, while recalling that the ECB set out adverse and severe scenarios in March with implications for growth and inflation.
Energy Price Shocks and ECB Policy Outlook
It is increasingly apparent that the impact of the stagflationary shock from US-Iran tensions will hit Europe harder than the US. With Brent crude futures for July delivery recently climbing to $94 per barrel, we see the European Central Bank being nudged to tighten policy earlier than markets expect. This external price pressure adds to domestic wage growth figures from Q1 2026 that were already running hot at 4.5%.
We expect a pre-emptive hike of 25 basis points in the deposit rate at the June 11 meeting, a move for which interest rate markets are currently pricing in only a 40% probability. This presents an opportunity in short-term interest rate derivatives, such as Euribor futures, which appear undervalued. A hawkish surprise from the ECB would cause these contracts to reprice sharply.
Market Volatility and Euro Strength
Given the increased uncertainty, we also anticipate a spike in volatility across Eurozone assets. We are considering buying volatility through options on the Euro Stoxx 50 index, as an unexpected rate hike would likely widen the daily trading ranges for equities. This situation is reminiscent of the market reaction to the energy crisis in 2022, where implied volatility remained elevated for several months.
This policy divergence, with the ECB turning more hawkish while the US is less affected, should also provide a tailwind for the euro. We believe a hawkish statement on June 11 could push the EUR/USD pair toward the 1.10 level. We are therefore looking at near-term call options on the euro to position for this potential strength.
While there is a likelihood of further rate increases in the second half of the year, the ECB will probably adopt a meeting-by-meeting approach. Our own 2026 growth forecast for the Eurozone is now moderated to 1.0%, reflecting the dual pressures of high energy costs and tighter credit conditions. This underlying economic weakness suggests that any strength in European assets may be short-lived, keeping volatility as a key theme.
