European shares dropped on Monday as expectations of a swift resolution to the Middle East conflict dimmed following the breakdown of U.S.-Iran negotiations and Washington's decision to impose a blockade around the Strait of Hormuz.
Major regional markets followed suit with contained losses, with Germany's DAX (.DAXI) and London's FTSE 100 (.FTSE) falling 1% and 0.4%, respectively.
Investors assessed the situation as U.S. announced preparations to blockade the strategic passage, threatening to choke off Iranian oil exports after diplomatic efforts between Washington and Tehran failed to produce any breakthrough in ending the ongoing war.
Rising tensions pushed oil prices above $100-per-barrel mark, reigniting inflation concerns that had only recently begun to subside.
"At the start of this week, traders are partly reversing last week's moves, but they are not back to panic levels, and some may argue that the sell-off could have been worse," said Kathleen Brooks, research director at XTB.
Monday's downturn follows a rally from last week, when the STOXX 600 gained 3% on optimism surrounding a temporary U.S.-Iran ceasefire, helping recoup some losses since hostilities began on February 28.
Energy stocks (.SXEP) were the gainers, rising 0.9%, on the back of soaring oil prices.
All other sectors tumbled into negative territory, and travel and leisure (.SXTP) companies led losses with a 2% drop.
Banks (.SX7E) and industrials (.SXNP) also weighed heavily on the benchmark index, down 1.3% and 1.2%, respectively.
Luxury stocks (.STXLUXP) fell 1.8%. Sales at Europe's biggest luxury brands have shrunk in Dubai and Abu Dhabi as the Iran conflict hit the sector's fastest-growing market.
On the monetary policy front, investors are bracing for the European Central Bank tilting towards raising rates in a sharp reversal from pre-war bets.
Markets are currently pricing in nearly three 25-basis-point rate increases by year-end, according to LSEG-compiled data.
Among other movers, Wise (WISEa.L) rose 4.3% after the British fintech group said cross-border transaction volumes rose 26% in the fourth quarter, reinforcing its expectation that annual profit margins will land near the top end of its forecast range.
As European trading continues, investor attention is shifting toward the U.S. earnings season, with Goldman Sachs (GS.N) set to kickstart major banks' quarterly results later in the day.
