Eurozone demand has been weaker than in 2022, which has helped to keep inflation contained even though supply constraints remain above historical averages. Since mid-2024, survey data show demand constraints have been the main factor, while supply-side constraints have continued to ease.
This shift has helped inflation return to the European Central Bank’s 2% target, though it has not moved below it because supply constraints are still higher than the historical average. The situation contrasts with the United States, where demand and inflation have stayed more sustained.
Inflation Drivers And Recent Data
Harmonised inflation rose by 0.6 percentage points to 2.5% year-on-year in March, attributed at this stage to higher fuel prices. Energy shocks, the conflict in Iran, and rising input price indices in business climate surveys are cited as factors that could later push core inflation higher.
Looking back at our analysis from 2025, the dynamic of weak demand containing inflation remains the central theme for the Eurozone. That core trend of demand constraints being more powerful than supply issues, which we identified starting in mid-2024, has largely persisted. This underlying weakness is keeping the European Central Bank from being overly aggressive on interest rate policy.
However, the supply-side risks we flagged last year are now materialising and should be the focus of our trading strategy. The latest flash estimate for March 2026 showed Eurozone inflation ticking up to 2.6%, primarily driven by the energy component as Brent crude now trades over $95 a barrel amid ongoing shipping disruptions. This is precisely the kind of scenario we were concerned about when we saw input prices rising in business surveys throughout 2025.
This puts the ECB in a difficult position, caught between sluggish growth and rising energy-driven inflation. Recent data confirms this divergence, with the March 2026 manufacturing PMI for the Eurozone still in contractionary territory at 47.1, signalling that the weak demand has not disappeared. The ECB is therefore unlikely to signal aggressive rate hikes, creating significant uncertainty about its next move.
Trading Strategy Implications
Given this uncertainty, traders should consider buying volatility on interest rate futures. A long straddle on December 2026 EURIBOR futures would profit from a significant rate move in either direction, whether the ECB is forced to hike to fight inflation or pivots to cutting rates as the weak economy falters. This strategy positions for a breakout from the current state of indecision.
Another approach is to trade the inflation curve itself using inflation swaps. We can bet on the front end of the curve rising while the back end remains anchored by poor long-term growth prospects. This involves setting up a “steepener” trade, paying a fixed rate on a 2-year inflation swap while receiving a fixed rate on a 10-year swap, profiting as near-term inflation fears outpace long-term expectations.
The geopolitical risks mentioned last year, specifically concerning energy supply, are now the primary driver of upside risk. With tensions in the Middle East keeping oil prices elevated, purchasing out-of-the-money call options on Brent or WTI crude futures offers a direct and capital-efficient way to speculate on a further supply shock. These positions provide exposure to a sudden spike in inflation and would act as a hedge against hawkish central bank surprises.
