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File image of ECB President Christine Lagarde. Image: Andreas Reeg/ECB.

The euro is still at risk of another oil price spike, but a 'hawkish' ECB repricing opens the door to robust gains when geopolitical angst settles.

Euro-dollar steadies in the 1.15-1.1650 range midweek, with further consolidation likely here as markets watch headlines out of the Middle East.

The contradictory newsflow concerning Middle East oil is doing enough to suppress EUR/USD volatility at this juncture.

Risks are still sizeable and any developments that suggest the blockage of oil and gas flow out of the region will be prolonged will potentially send the euro-dollar below 1.15 support.

However, this pain trade could be short-lived as commentary from U.S. President Donald Trump shows he's acutely attuned to oil prices and the exchange rate is poised for a decent recovery when the situation resolves.

Interest rate developments are a key reason to believe in a euro-dollar recovery: the market has shifted to expecting a rate rise from the European Central Bank in 2026, with the 'hawkish' repricing being more prominent in the Eurozone than has been the case in the U.S.

ECB President Christine Lagarde underpinned the moves when she said Tuesday the ECB won't allow a repeat of the 2022-23 inflation increases, implying it stood ready to raise rates if needed.

Midweek, Governing Council member Peter Kazimir said a rate hike on the back of the Iran conflict may be closer than thought.

"That will do little to defuse markets’ aggressive hawkish bets, with a 25bp rate hike fully priced in within the next six months," says a daily FX briefing from ING.

Governing Council member Isabel Schnabel said in New York on March 06 that a "constellation of factors poses upside risks to the future trajectory of domestic inflation."

Traditionally more 'hawkish' amongst her peers, Schnabel said "we cannot be complacent. We need to be vigilant as the current geopolitical and macroeconomic environment creates upside risks to inflation over the policy-relevant horizon."

The shift in inclination towards rate hikes should offer the euro some support and limit EUR/USD weakness while increasing prospects of a more robust recovery once geopolitics settle.

Interestingly, however, ING's currency strategists say that the euro has proven less responsive to interest rate expectations than has traditionally been the case.

This cuts two ways for EUR/USD: if it doesn't respond to the EUR's rate advantage, then the outlook is less bullish than might be implied by recent developments.

Indeed, ING economists see less of a chance of an ECB rate hike than money markets do.

But, at the same time, "it’s important to note that this does not automatically translate to a view of EUR weakness. The beta of EUR/USD to short-term rate differentials has dropped to virtually zero, meaning expectations for ECB policy moves are having very little impact on the euro," says ING.

The bank says the currency will simply benefit when the Middle East conflict settles and oil prices start falling.