Eurozone data and European Central Bank (ECB) comments indicate rising downside risks for the euro, linked to the Iran war and an energy price shock affecting growth and sentiment. The euro has been the weakest among major currencies, alongside outflows from other lower-yielding currencies such as the JPY, SEK and NZD.
ECB Governing Council member Dimitar Radev said the euro-area outlook may be worsening more than expected, with higher uncertainty and stronger transmission of shocks into inflation expectations. He said the chance of a more adverse scenario has increased.
Rising Risks For The Euro
Radev said that if the shock feeds into wages, profit margins and inflation expectations, the cost of delaying action would rise, supporting a faster policy response. He also said it is too early to know whether there will be enough data for a clear decision at the ECB’s April meeting.
Governing Council member Pierre Wunsch said the ECB may need to start raising interest rates as soon as April and keep tightening if the energy shock persists. Inflation has risen to 2.5% in March, and he warned it could rise further if second-round effects take hold.
The Euro continues to be the main underperformer as capital flows out of the region and into higher-yielding currencies. The ongoing Iran war and the related energy shock are creating serious downside risks for European growth and sentiment. This situation creates a difficult choice for the European Central Bank as it faces slowing growth but rising inflation.
We are seeing the direct impact of sustained high energy costs, with Brent crude having surged over 40% since the conflict began late last year, now trading above $125 a barrel. This is hitting the manufacturing sector hard, particularly in Germany, where factory orders have declined for a third consecutive month. The latest Eurozone Manufacturing PMI reading of 45.8 clearly signals a deepening contraction.
Market Volatility And Policy Tradeoffs
ECB officials are clearly nervous about second-round inflation effects, where high energy costs bleed into wages and core prices. They are referencing the policy mistakes made in 2022, when they were perceived as being too slow to tackle the initial inflation surge. This memory is pushing them towards a more aggressive stance now, even as the economy weakens.
This conflict between a hawkish central bank and a deteriorating economy is creating significant market uncertainty. European equity volatility has been rising, with the VSTOXX index climbing over 30% since the conflict escalated in the fourth quarter of 2025. For derivative traders, this means option premiums are becoming more expensive, reflecting the increased risk of sharp market moves.
Given the pressure on the economy, the path of least resistance for the Euro is lower, particularly against the U.S. dollar. We have already seen the EUR/USD exchange rate fall from over 1.10 last autumn to below 1.05 recently, and further downside seems likely. We should be positioned for this by considering buying puts on the Euro or establishing bearish put spreads.
In the coming weeks, we must watch the upcoming Eurozone flash CPI data and any reports on wage negotiations very closely. The ECB has signaled that its April interest rate decision is data-dependent and will hinge on whether inflation is becoming embedded. Any sign of accelerating wage growth could force them to hike rates into a slowing economy, further pressuring the Euro.
