Less than a week after the outbreak of the conflict between the U.S. and Iran, the European bond market has already suffered severe damage. Inflation concerns triggered by soaring energy prices are forcing investors to completely reassess the interest rate paths of the European Central Bank and the Bank of England.
On Thursday, Eurozone and UK government bonds continued to decline, with the yield on Germany's 10-year government bonds rising by a cumulative 18 basis points this week, while the yield on UK bonds of the same duration surged by 29 basis points. German government bonds are facing their worst weekly performance in nearly a year, and the yield on Germany's two-year government bonds has also recorded the largest weekly increase since 2023.
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According to Bloomberg, Morgan Stanley has withdrawn its prediction of two rate cuts by the European Central Bank in 2026, while Rabobank has removed all expectations for rate cuts in the UK in 2026.
The core of this shock lies in Europe's high dependence on energy imports. The U.S. and Israel launched airstrikes against Iran last Saturday, and there are no signs of easing in the conflict so far. Brent crude oil has risen nearly 15% this week, approaching $84 per barrel, while West Texas Intermediate crude is nearing $77 per barrel. The sharp rise in energy prices has shattered the previous market expectation that the European Central Bank would keep interest rates unchanged.
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<h2>Rate Cut Expectations Fully Reversed, Rate Hike Bets Quietly Rising</h2>
Before the outbreak of the conflict, the market's judgment on the European Central Bank's interest rate direction this year was highly consistent, namely to maintain rates unchanged. This expectation had previously pushed the implied volatility in the European interest rate market to a five-year low. In the UK, supported by a cooling labor market and weakening inflation, the market had generally expected the Bank of England to implement a rate cut this month, which provided strong support for UK government bond demand.
However, the outbreak of war quickly undermined this logic. According to Bloomberg, Morgan Stanley no longer expects the European Central Bank to implement two rate cuts in 2026, citing a significant increase in uncertainty regarding the inflation outlook. Meanwhile, traders have begun to price in the possibility of rate hikes. David Zahn, head of European fixed income at Franklin Templeton, stated that European inflation is likely to rise, and although he does not expect rate hikes to be imminent, the timing of rate hikes &#34;may be brought forward.&#34;
Rabobank has removed all of its 2026 UK rate cut forecasts, citing that soaring natural gas and oil prices are delivering negative supply shocks to the UK. Goldman Sachs has also postponed its expectations for the next rate cut by the Bank of England.
<h2>The Strait of Hormuz as a Key Variable, Systemic Risks Cannot Be Underestimated</h2>
The direction of the Strait of Hormuz will become a core variable defining the intensity and duration of this crisis. Although Iran has not officially closed this globally crucial oil transport chokepoint, a situation of effective suspension of shipping routes is beginning to form as the threat of conflict approaches
Elwin de Groot, the head of macro strategy at Rabobank, warned in a recent report that if the Strait of Hormuz is blocked, the resulting impact will be far more than just soaring oil prices, but rather a &#34;cascading, systemic global crisis.&#34; He pointed out that the shock of disrupted energy supplies will quickly transmit to sectors such as petrochemicals, fertilizers, food production, metals, power grids, and semiconductor manufacturing, ultimately threatening national fiscal foundations and social order stability.
<h2>Euro Under Pressure, Shadows of the 2022 Energy Crisis Reemerge</h2>
The euro continues to be under pressure in this round of risk aversion. Bloomberg analysis pointed out that the eurozone's deep reliance on overseas energy constitutes a structural weakness in its exchange rate—during the Russia-Ukraine conflict in 2022, the euro once fell below parity with the dollar, and the current situation is rapidly raising market concerns about a historical repeat.
The fragility of market sentiment also reflects disappointment over the central bank's silence. Pooja Kumra, a senior analyst in interest rate strategy at Toronto-Dominion Bank, stated that part of the reason for the increased turmoil is the &#34;central bank's lack of any soothing communication&#34;; however, in a highly uncertain environment, decision-makers also find it difficult to lock in policy paths in advance.
European Central Bank Vice President Luis de Guindos admitted on Thursday that if the conflict continues, inflation expectations will begin to shift. He emphasized that although the eurozone economy showed resilience before the conflict, its future direction now entirely depends on the evolution of the geopolitical situation. During the trading session, the market briefly stabilized due to Iran's signal of willingness to abandon uranium reserves, but yields subsequently rose again, indicating that investors are gradually accepting the reality that the conflict may become prolonged

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Less than a week after the outbreak of the US-Iran conflict, inflation concerns triggered by soaring energy prices have completely reversed market interest rate expectations. This week, the yield on Germany's 10-year government bonds rose a total of 18 basis points, marking the largest weekly increase in nearly a year; the yield on the UK's 10-year government bonds surged by 29 basis points. Morgan Stanley has withdrawn its prediction of two rate cuts by the European Central Bank in 2026, while Rabobank has completely removed its bets on rate cuts in the UK in 2026. The market has begun to price in interest rate hikes, with the shadow of the 2022 energy crisis reappearing

- The European bond market has significantly declined amid rising energy prices and inflation concerns following the conflict between the U.S. and Iran.  
- Both Morgan Stanley and Rabobank have retracted predictions of interest rate cuts from the European Central Bank and the Bank of England for 2026, attributing this to increasing inflation uncertainties.  
- The conflict's implications extend beyond financial markets, threatening broader economic stability as disruptions in energy supply could lead to a systemic global crisis.

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European debt "darkest hour": War cuts off interest rate cut path, German bond yields record largest weekly increase in a year