The calm lasted precisely one day. European bond markets briefly stabilised before resuming their descent, as investors digested a reality that central bankers would rather postpone confronting: energy shocks and wars have a habit of rewriting monetary policy. Government debt across the euro area and the United Kingdom resumed its slide on Thursday. The conflict with Iran shows no sign of abating, and energy prices continue their relentless ascent. What began as a geopolitical tremor is rapidly becoming a macroeconomic event.
German Bunds — the region’s supposed sanctuary — are now heading for their worst week in a year. Markets have swiftly recalibrated expectations for the European Central Bank. Investors who only weeks ago assumed a long period of policy stability now assign a 75% probability to an ECB rate increase by the end of 2026. The shift is telling. Global sovereign bonds have declined this week, but Europe stands uniquely exposed. Its economic architecture remains structurally dependent on imported energy, making the continent exquisitely sensitive to any renewed inflationary shock.
Only a month ago volatility indicators in European bond markets had fallen to their lowest levels in five years. Investors believed the inflation storm had passed. The ECB would sit still. The cycle had matured. The world had returned to something resembling normality. Then came the weekend. The United States and Israel launched coordinated strikes on Iran, igniting a new phase of conflict in the Middle East. Within days, analysts began revising their interest-rate forecasts. Morgan Stanley has abandoned its expectation of two ECB rate cuts in 2026. Traders are now tentatively pricing the opposite.
David Zahn of Franklin Templeton summarised the new consensus with measured understatement: inflation in Europe is likely to be higher. While he does not foresee an immediate rate increase, he conceded that tightening “could be brought forward”. In Britain, the adjustment has been equally abrupt. Rabobank has removed rate cuts from its 2026 forecasts altogether, arguing that the country now faces a classic negative supply shock driven by soaring oil and gas prices. Goldman Sachs has similarly pushed back its expectations for the Bank of England’s easing.
The central question is duration. If the conflict remains brief, energy markets may stabilise. If it persists, the consequences multiply rapidly. The Strait of Hormuz sits at the centre of the anxiety. Although Iran insists the passage remains open, the reality is more ambiguous. Shipping traffic has effectively halted under the weight of risk. When ships refuse to sail, a chokepoint becomes a blockade in all but name. The implications extend far beyond oil and gas. Energy supply disruptions propagate through petrochemicals, fertilisers, food production, metals, electricity networks and semiconductors before eventually reaching fiscal balances and social stability. Inflation shocks do not remain confined to commodities; they migrate through entire economies.
The euro has already begun to feel the pressure. Europe’s energy vulnerability was brutally exposed during the 2022 crisis following Russia’s invasion of Ukraine, when the single currency briefly slipped below parity with the dollar. The same structural weakness now looms once again. Meanwhile, Brent crude has climbed to roughly $84 per barrel, pushing weekly gains close to 15%. West Texas Intermediate trades near $77. China, the largest buyer of Iranian oil, has reportedly instructed major refiners to suspend exports of diesel and gasoline — an early sign that supply chains are already adjusting.
Markets continue to oscillate between fear and hope. Periodic rumours of ceasefire negotiations briefly stabilise bonds, only for yields to resume climbing hours later. Even a report suggesting Iran might relinquish uranium stockpiles offered only fleeting relief. The numbers tell the story. The yield on Germany’s ten-year Bund has risen twenty basis points this week. The two-year Bund is experiencing its sharpest weekly move since 2023. British two-year yields have surged twenty-eight basis points. Behind the volatility lies a deeper frustration among investors: the silence of central banks. Amid such profound uncertainty, policymakers have offered little reassurance.
European policymakers have begun acknowledging the dilemma. ECB Vice-President Luis de Guindos warned that inflation expectations could shift if the conflict drags on. Before the war, the euro-area economy had shown signs of resilience. Now, the trajectory depends less on economic fundamentals than on the evolution of geopolitics. Bond markets, which had convinced themselves that the cycle was ending, are rediscovering an old truth: inflation is rarely defeated by consensus. It is defeated by circumstance. And circumstance, at the moment, is sailing through the Strait of Hormuz.