Euro area assets remain sensitive to an energy shock linked to the war in Iran, alongside rising oil prices. ECB officials have signalled patience on interest rates despite the higher energy costs. BNY’s Head of Markets Macro Strategy Bob Savage said energy supply problems could lead to a larger fiscal impulse. He said this could make it harder for central banks to keep inflation expectations contained, especially if pressure to ease policy rises while financial conditions tighten due to dollar moves and spread changes.

ECB Signals Patience On Energy Shock

The ECB’s communication on the Iran conflict has added to worries in EU bond markets, with attention on France. Banque de France Governor François Villeroy de Galhau said there is no reason at this stage to raise interest rates in response to higher oil prices and that policymakers will reassess at their next meeting in two weeks. Villeroy de Galhau said central banks often look through one-off energy shocks. He said the current situation is not comparable to the 2022 inflation surge after Russia’s invasion of Ukraine. He said the conflict is a negative shock for the European economy. ECB Vice President Luis de Guindos said “a different approach” is now required for policy. Looking back at the Iran energy shock last year, we saw European Central Bank officials urge patience. They chose to look through the oil price spike, unlike the more aggressive response we saw after Russia’s invasion of Ukraine in 2022. This established a precedent for a more cautious ECB, hesitant to tighten policy based on temporary supply-side shocks.

Positioning Implications For Rates And Fx

This cautious stance from 2025 appears justified given today’s data. Brent crude is trading around $82 a barrel, well below the highs seen during that conflict and significantly lower than the $120 peaks of 2022. This moderation in energy prices removes a key driver for emergency rate hikes and supports the ECB’s decision to wait. Furthermore, the latest inflation figures for the Euro area came in at 2.6% for February, continuing the steady decline towards the 2% target. This shows that the underlying price pressures are easing, suggesting the 2025 energy shock did not entrench higher inflation expectations as some had feared. This disinflationary trend gives the central bank more room to maneuver. Given this backdrop, we should position for the ECB to begin easing policy later this year. Interest rate markets are already pricing in approximately 90 basis points of cuts for 2026, so we are using interest rate swaps to receive the fixed rate in anticipation of floating rates falling. This strategy benefits directly from the expected shift to a more dovish monetary policy. The divergence in policy with a still-cautious US Federal Reserve suggests continued pressure on the euro. We are therefore adding to short EUR/USD positions through options, targeting a move below the 1.08 level in the coming weeks. A less aggressive ECB relative to the Fed makes a weaker euro the path of least resistance. However, the fiscal concerns in countries like France, which were highlighted during last year’s turmoil, have not disappeared. To hedge against any sudden widening of sovereign bond spreads or a flare-up in market anxiety, we are buying VSTOXX call options. This provides a cheap way to protect against unexpected volatility in European equities. Create your live VT Markets account and start trading now.

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