ECB takes centre stage as oil risks rise

Market overview

Renewed tensions in the Middle East have pushed energy markets back to the centre of the global outlook, with Brent crude trading near $96 a barrel and investors reassessing the risks to inflation, interest rates and currencies. Attention now turns to today’s ECB meeting, where policymakers are expected to keep rates unchanged while maintaining a hawkish stance. Any signal that a September increase remains possible could support the euro, although persistently higher energy prices continue to threaten the region’s growth outlook and may limit its upside.

FX volatility remains unusually subdued, with investors continuing to favour higher-yielding commodity currencies. The Brazilian real, South African rand and Mexican peso have performed strongly, while the Norwegian krone has led gains across the G10.

However, current market calm may prove fragile. A sustained rise in oil prices would increase pressure on global inflation, reduce expectations for monetary easing and test the resilience of risk assets. Further disruption in the Red Sea, including reported attacks on Saudi vessels, adds another layer of uncertainty.

USD: Oil strength supports the dollar outlook

The dollar has gained alongside rising oil prices and higher short-term US Treasury yields. Markets are beginning to consider whether another energy-driven inflation shock could force the Federal Reserve to maintain tighter policy for longer, or even bring a further rate rise back into consideration before year-end.

For now, the US economy appears better placed to absorb higher energy costs than during previous oil shocks. However, a prolonged increase in petrol, freight and inflation expectations would be difficult for the Fed to ignore, particularly if underlying inflation remains firm.

The dollar’s gains have so far been restrained by stable risk sentiment and increasingly hawkish expectations for other major central banks. If oil prices stabilise, attention should return to softer US inflation data and next week’s Fed meeting, potentially limiting further dollar strength. A continued move higher in Brent would instead favour rising yields, a flatter Treasury curve and renewed USD demand.

GBP: Sterling gives back recent gains

Sterling has underperformed this week, although the decline appears to reflect profit-taking following its recent rally rather than a significant change in the UK outlook.

Comments from Andy Burnham about using greater flexibility within the fiscal rules briefly unsettled markets, but the broader rise in long-term borrowing costs appears more closely linked to geopolitical concerns and higher oil prices.

GBP/EUR has moved below 1.17, bringing the 1.16 area into focus as the next notable support level. This also sits close to the 21-day moving average. However, with the euro facing its own risks ahead of today’s ECB decision, an immediate move towards 1.16 may be premature.

EUR: ECB support faces a difficult test

EUR/USD remains confined to a narrow 1.14 to 1.15 range, with limited momentum in either direction. Higher energy prices have encouraged markets to price a firmer ECB response, helping the euro remain resilient despite a weaker growth outlook and European gas prices returning to March highs.

This support may now be close to its limit. Markets already expect around two ECB rate increases by year-end, leaving a high bar for President Lagarde to deliver a further hawkish surprise. Higher energy costs may lift inflation and interest-rate expectations, but they also place additional pressure on eurozone activity.

The ECB is expected to leave rates unchanged while keeping the possibility of a September increase alive. A hawkish hold could provide short-term support for the euro and delay a break below its recent range. However, unless energy prices ease or diplomatic progress reduces tensions in the Gulf, the near-term bias remains towards 1.1380.

Looking ahead

• The ECB is expected to leave rates unchanged today while maintaining a hawkish message.

• Any signal that a September rate rise remains under consideration could support the euro.

• Brent crude remains the key driver for inflation expectations, bond yields and the dollar.

• Further disruption to Gulf or Red Sea supply routes could trigger a sharper rise in FX volatility.

• Next week’s Federal Reserve meeting will determine whether recent softer inflation data can outweigh renewed energy pressures.