European shares edged lower on Monday as escalating tensions between the United States and Iran pushed oil prices higher, raising concerns over inflation and dampening investor sentiment ahead of a busy week of corporate earnings and the European Central Bank's policy meeting. According to Reuters, the pan-European STOXX 600 index was down 0.2% at 640.45 points by 0703 GMT, as the decline came as oil prices climbed sharply after the U.S. military campaign against Iran entered its ninth consecutive day, intensifying concerns over global energy supplies. This market weakness comes as euro zone bond yields held near multi-year highs amid growing concerns that the United States and Iran may return to an all-out war, as reported by RTT News.
German bond yields experienced a significant uptick as oil prices climbed, following dramatic swings over the re-escalation of Middle East conflict and release of U.S. inflation data. According to The Economic Times, Germany's two-year bond yield rose 2 basis points to 2.79% after touching 2.8174%, its highest level since July 2024. The yield has risen 9 basis points this week and 26 basis points in July as traders fear the renewed climb in oil and gas prices after fighting resumed between Iran and the U.S. in the Gulf could push inflation higher and force the European Central Bank to raise rates more aggressively. Brent crude rose 3% to above $90 a barrel following reports that tankers were being immobilised, increasing fears of disruptions to shipping through the Strait of Hormuz, a key global oil transit route. Germany's 10-year bond yield also increased by 2 basis points to 3.15%, with the yield having climbed to 3.20% in mid-May, marking its highest level since May 2011. Italy's 10-year government bond yield rose 3.5 basis points to 3.83%, with the spread between Italian and German 10-year bond yields widening to 82 basis points, the highest level since early May.
A jump in oil prices over the last week has seen traders sharply raise their bets on ECB rate hikes this year, with money markets now pricing the ECB's deposit rate at 2.69% by December and 2.77% by February 2027, compared with the current rate of 2.25%. According to The Economic Times, traders have fully priced in a rate hike at the ECB's September policy meeting, with money markets last pricing in 40 bps of further ECB tightening this year, up from 30 bps a week ago but down from a peak of 48 bps on Tuesday. However, current market pricing still points to a roughly 20% chance of a hike for next week's July 22 meeting, as reported by Reuters. The ECB is widely expected to leave interest rates unchanged as policymakers assess the inflation outlook and the broader economic impact of rising geopolitical tensions and elevated energy prices. The ECB slashed interest rates four times in the first half of 2025, taking its key deposit rate from 3% at the start of the year to 2% by mid-June, but was forced to change course last month, hiking by 25 basis points to its current rate of 2.25%.
The surge in crude prices created mixed sectoral performance across European markets. The energy sector emerged as the top performer, gaining 1.4% as investors sought exposure to oil producers benefiting from stronger crude prices. However, travel and leisure stocks fell 1.3%, weighed down by expectations that rising fuel costs could pressure airline profitability. Ryanair was the biggest drag on the STOXX 600, tumbling 4.6% after reporting a 34% decline in first-quarter profit. The budget carrier's earnings were hit by higher fuel expenses and lower ticket fares, according to Reuters. In contrast, technology stocks bucked the broader market trend, rising 0.4% as investors looked ahead to earnings from major U.S. technology companies later this week. Despite strong results recently from chip industry leaders, investor enthusiasm has remained measured, with upbeat guidance from Dutch semiconductor equipment maker ASML and robust earnings from Taiwan Semiconductor Manufacturing Co. (TSMC) failing to generate a sustained rally in technology shares.
Policymakers face additional challenges as eurozone inflation eased to 2.8% last month despite a 8.7% year-on-year increase in energy costs, as core inflation was restricted to 2.4% — suggesting limited "second-round" inflation effects in the rest of the economy, according to Reuters. Austrian central bank chief Martin Kocher told German newspaper Börsen-Zeitung that "we are paying particular attention to the indirect price effects of the war in the Middle East and possible second-round effects," noting they currently see no second-round effects but must align monetary policy with inflation expectations. The eurozone economy contracted by 0.2% year-on-year in the first quarter of 2026, adding caution to policymakers' approach. Initial estimates for second-quarter GDP growth and July inflation will not be available until July 30 and July 31 respectively, meaning next week's rates decision will be made without access to the most recent data. Market analysts noted that the strong relationship between oil prices and short-dated euro zone bond yields, a trend that shaped trading during March, April and May, has re-emerged as energy prices continue to rise.
