Euro struggles to extend gains as Middle East tensions support the US Dollar

• EUR/USD trades around 1.1415 on Wednesday, up 0.15% on the day, and remains capped below 1.1420.
• Escalating tensions between the United States and Iran continue to support demand for the US Dollar as a safe-haven asset.
• ING says expectations for further European Central Bank tightening continue to provide support for the Euro.

EUR/USD trades around 1.1415 at the time of writing on Wednesday, up 0.15% on the day, but its recovery remains limited after failing to break above 1.1420. The pair maintains a cautious tone as rising geopolitical tensions in the Middle East continue to fuel demand for safe-haven assets, limiting the US Dollar (USD) downside.

Investor concerns intensified after another escalation between Washington and Tehran. The United States (US) launched fresh strikes against Iranian targets, while US President Donald Trump warned that any Iranian attack on a vessel in the Strait of Hormuz would trigger US strikes against key Iranian infrastructure, including bridges and power plants. These developments continue to weigh on market sentiment and reinforce risk aversion.

Meanwhile, Oil prices continue their sharp rally, gaining more than 25% since tensions in the region escalated. The surge in energy prices is a headwind for the Eurozone economy, which remains highly sensitive to higher energy costs, limiting the Euro's (EUR) upside potential.

Despite this backdrop, the common currency continues to find support from expectations surrounding the European Central Bank (ECB) monetary policy meeting scheduled for Thursday. The ECB is widely expected to leave interest rates unchanged, although markets continue to price in additional policy tightening in the coming months if energy-driven inflationary pressures persist.

Euro holds firm as ECB expectations offset energy rebound

Analysts at ING note that EUR/USD has "been performing relatively well despite the rebound in energy prices that has seen natural gas prices retesting the March highs of EUR60/MWh." They argue that "interest rate differentials have probably had a say here, with higher oil prices seeing investors price a more aggressive tightening response from the European Central Bank than the Federal Reserve."

Looking ahead, ING says that, "barring a near-term move towards another cease-fire between the US and Iran, our bias remains for EUR/USD to drift back to 1.1380 and then take its cue from tomorrow's ECB meeting." However, the bank cautions that, "as our team points out in their ECB cheat sheet, it is hard to see the market pricing in even higher ECB rates, regardless of the language delivered at tomorrow's ECB meeting and press conference."

The US Dollar, however, remains supported by safe-haven demand. The US Dollar Index (DXY) holds above 101.00 after recovering part of its earlier daily losses. Investors continue to favor the Greenback as geopolitical risks intensify, even though recent US inflation data has reduced expectations that the Federal Reserve (Fed) could tighten monetary policy in the coming months.