François Villeroy de Galhau, a member of the European Central Bank Governing Council and Governor of the Bank of France, spoke about monetary policy on Monday. He said policymakers are ready to act if inflation driven by energy spreads more widely. He said it is too early to discuss the timing of any interest rate rise, despite rising market expectations. He described an energy shock linked to the Iran war as inflationary in the near term, but said the ECB cannot prevent the initial price spike.

Policy Focus On Second Round Inflation

He said policy is aimed at second-round effects rather than the first-round rise in energy prices. At the time of reporting, EUR/USD was down 0.14% on the day at 1.1492. Looking back, we can see how the comments from early 2025 framed the current market. The focus then was on whether the Iran war-driven energy shock would create broader, second-round inflation effects. It was clear even then that the European Central Bank could not stop the initial price surge but was poised to act on its aftermath. Those second-round effects did materialize, which is why we are where we are today. The latest Eurostat flash estimate shows headline inflation has cooled from its 2025 peak but remains sticky at 2.9%, well above the target. This persistence forced the ECB to hike its deposit facility rate to the current 4.25%, where it has remained for the last five months. Now, traders face a conflict between stubbornly high core inflation and deteriorating economic growth, with the last quarter’s GDP figures showing a meager 0.8% annualised expansion. This puts the ECB in a difficult position, creating uncertainty about its next move. Therefore, we believe positioning for increased volatility is a primary strategy for the coming weeks.

Strategies For Volatility And Rates

Traders should consider using options to play this divergence, such as buying straddles on the Euro Stoxx 50 Volatility Index (VSTOXX). This strategy profits from a large market move in either direction, whether the ECB signals a hawkish surprise to crush inflation or a dovish pivot to support the economy. The cost of these options remains historically reasonable, providing an attractive risk-reward profile. In interest rate markets, futures are pricing in nearly 75 basis points of cuts by year-end, which seems aggressive given recent wage growth data. We see an opportunity in positioning for a slower cutting cycle than the market expects. This could involve using Euribor futures to bet against the most dovish contracts for the fourth quarter of 2026. The EUR/USD exchange rate, now trading near 1.0750, never regained its footing after failing to rally on those hawkish comments last year. While the path of least resistance appears lower due to growth differentials with the US, the market is heavily short the Euro. We advise using cheap, out-of-the-money call options as a hedge against any unexpected hawkish rhetoric from the ECB that could trigger a sharp short squeeze. Create your live VT Markets account and start trading now.

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