Euro faces headwinds as energy repricing lifts inflation to 3.2%

Surging energy costs tied to Middle East supply risks are reshaping the euro's outlook against the dollar, with euro-area inflation accelerating to 3.2% in May.

Surging energy costs tied to Middle East supply risks are reshaping the euro's outlook against the dollar, with euro-area inflation accelerating to 3.2% in May as oil prices climb, ABN Amro said.

"Energy repricing is creating a structural headwind for the euro at a time when the European Central Bank faces a difficult trade-off between inflation and growth," strategists at ABN Amro wrote in a note dated July 8.

Euro-area core inflation rose to 2.4% in May from 2.2% in April, matching the consensus estimate, as rising energy costs filtered through the economy, according to Eurostat. Oil prices moved higher as traders bet that negotiations between the US and Iran over reopening the Strait of Hormuz — which handles about 21% of global oil trade — would drag on. The Israel-Hezbollah conflict added another layer of complexity to supply-side risks.

The energy-driven inflation pickup complicates the ECB's policy path. Forex traders are preparing for the possibility of another rate-hike cycle in developed economies, which could support the euro if the ECB tightens — but higher energy costs also threaten the region's growth outlook, creating two-way risk for the single currency.

Inflation Accelerates to 3.2% on Energy Costs

The euro area's headline inflation rate increased from 3% in April to 3.2% in May, driven primarily by rising energy costs. Core inflation grew from 2.2% to 2.4%, exceeding the analyst consensus of 2.4%. The data highlights the challenge facing ECB policymakers as they assess whether the recent inflation spike is transitory or reflects a more persistent trend.

The last time euro-area inflation accelerated due to an energy supply shock was in 2022 following Russia's invasion of Ukraine, when the euro fell below parity against the dollar. The single currency has since recovered but remains sensitive to energy price dynamics, with the correlation between oil prices and EUR/USD remaining elevated.

Strait of Hormuz Talks Keep Oil Premium Elevated

Oil prices moved higher as traders bet that US-Iran negotiations would take time. President Trump said this week that a memorandum of understanding with Iran, which would reopen the Strait of Hormuz, could be ready within the next week, adding that negotiations continued at a rapid pace. Recent reports indicated that Iranian officials were discussing the final version of the proposal that would be sent to the US.

The Israel-Hezbollah conflict continued despite Trump's efforts to negotiate a truce, adding a geopolitical premium to energy markets. The Strait of Hormuz handles about 21% of global oil trade, making any disruption a significant risk for energy-dependent economies like the euro area.

Gold is swinging between gains and losses as traders focus on geopolitical developments and react to inflation data. The nearest resistance level for gold is located in the $4,530 to $4,550 range. This resistance level has already been tested several times and proved its strength. If gold settles above $4,550, it could head toward the 50-day moving average at $4,629.

Silver gained some ground as the gold-silver ratio pulled back below 59.50, indicating increased risk appetite despite rising oil prices. Silver continues to test its 50-day moving average at $76.08. A move above this level could open the path toward resistance at $78.00 to $79.00.

For the euro, the energy-inflation dynamic creates a complex outlook. Higher interest rates in developed economies could support the single currency if the ECB follows other central banks in tightening, but the growth impact of elevated energy costs may weigh on the region's economic recovery.

This article is for informational purposes only and does not constitute investment advice.