How the ECB’s First Rate Hike in Years and Trump’s Iran Pivot Lifted European Markets

The decision was driven by an inflation shock tied directly to the Iran war. Eurozone consumer prices accelerated to 3.2% in May from 3% in April, well above the central bank’s 2% target, as energy costs soared . The conflict had already triggered the closure of the Strait of Hormuz, threatening global oil supply and pushing Brent crude above $93 per barrel . This energy-driven inflation forced the ECB into a stagflationary dilemma: hiking rates to tame prices while risking further damage to an already slowing eurozone economy .

The hike was almost fully priced in by markets, which had assigned a roughly 91% probability beforehand . As a result, the euro dropped in a classic "buy the rumor, sell the fact" move, and government bond yields across the bloc dipped .

Trump’s Iran de-escalation

The market session was dominated by extraordinary U.S.-Iran volatility. Early on Thursday, President Trump posted on social media a blunt warning that the U.S. would strike Iran "VERY HARD TONIGHT" and that it would "assume total control" of Iran’s oil and gas sectors, specifically referencing the Kharg Island terminal . This rhetoric initially spiked oil prices and risk premiums, directly benefiting energy stocks .

Only hours later, Trump abruptly reversed course. He announced on Truth Social that he had "canceled the planned strikes and bombings against Iran for this evening," stating that discussions with the Islamic Republic’s leadership had "reached the highest levels and received their approval" . He later said an agreement was "pending the finalization of documents," which could potentially be signed within the weekend .

This withdrawal of an immediate massive escalation calmed markets, easing fears of a wider regional war that could severely disrupt energy supply routes . However, Trump indicated a naval blockade would continue, leaving the situation fragile .

Sector performance and broader context

The market rally was spearheaded by sectors directly tied to the day’s events:

• Energy shares led the Stoxx 600 with a gain of almost 2%, their best daily performance in a month, as crude prices remained elevated throughout the session .
• Bank stocks advanced 0.6%, buoyed by the ECB rate hike which improves the profitability of lending by widening net interest margins .
• Technology stocks also contributed positively, helped by gains in semiconductor names including ASML .

Investors looked past the verbal escalation from Washington to focus on the ECB's decisive action and the late-cycle signal of de-escalation .

The path forward: a stagflation bind

The ECB retained its standard flexible guidance, refusing to pre-commit to any future rate path . However, analysts at MUFG noted that "a July hike is more likely than not" now that the threshold for tightening has been reached . Markets are pricing in a total of two 25 basis point hikes this year, with a risk of a third, depending on how the Iran-driven inflation shock evolves .

The central bank is walking a tightrope. Aggressive rate hikes risk choking economic growth already under pressure from high energy costs—a stagflation scenario that RSM described as "every central banker’s worst nightmare" . For now, the ECB has signaled it will do what it takes to anchor inflation at 2%, but the fog of war over the Middle East makes the economic outlook highly uncertain.