[Christian Harris]

The euro surged above $1.085 on Friday, marking its highest level since November 5th and positioning it for a 4.6% weekly gain—its strongest performance since March 2009.

This rally was driven by a confluence of factors, including Germany’s ambitious fiscal reforms, a more cautious tone from the European Central Bank (ECB) regarding future rate cuts, and a weaker US dollar amid concerns over President Donald Trump’s threats of trade wars.

Germany’s Fiscal Reforms

Germany’s major political parties, including the Christian Democratic Union (CDU), Christian Social Union (CSU), and Social Democrats (SPD), announced plans to reform the country’s debt brake, a constitutional rule limiting government borrowing.

The reforms would exempt defense spending exceeding 1% of GDP from the debt brake, allowing Germany to increase its defence budget to meet NATO’s 2% target.

Additionally, the parties proposed a €500 billion ($535 billion) infrastructure fund aimed at modernising the country’s infrastructure and stimulating economic growth.

These measures represent a significant shift in Germany’s fiscal policy, which has long been characterised by strict austerity.

European Defence Spending

European leaders agreed on Thursday to a substantial increase in defence spending, part of a broader strategy to strengthen Europe’s defence industry and enhance military capabilities.

This decision comes in response to geopolitical uncertainties, including the US scaling back military support for Ukraine and the potential for increased trade tensions under the Trump administration.

The European Commission’s ReArm Europe plan, which aims to mobilise up to €800 billion in defence-related investments, further underscores the continent’s commitment to bolstering its defence infrastructure.

ECB Policy & Monetary Outlook

The ECB delivered a widely anticipated 25 basis point rate cut on Thursday, bringing the benchmark deposit rate to 2.50%.

While the central bank acknowledged that monetary policy is becoming “meaningfully less restrictive,” it signalled a possible pause in further rate reductions.

ECB President Christine Lagarde emphasised that the disinflation process remains on track but cautioned that risks to the eurozone economy are tilted to the downside due to trade tensions and geopolitical uncertainty.

Traders now expect one or two additional 25 basis point cuts later this year, depending on economic conditions.

Weaker Dollar & Trade Concerns

The US dollar’s decline has also contributed to the euro’s rally. Concerns over President Trump’s threatened tariffs on European goods and the potential for escalating trade wars have weighed on the dollar, making the euro more attractive to investors.

The dollar’s weakness reflects broader uncertainties about the US economic outlook, particularly in light of the Trump administration’s unpredictable trade policies.

Market Implications

The euro’s strong performance reflects growing confidence in Europe’s economic and fiscal policies, as well as the ECB’s measured approach to monetary tightening.

Germany’s fiscal reforms and the EU’s commitment to increased defence spending are expected to provide a significant boost to economic growth across the continent.

However, challenges remain, including the potential for further trade tensions and the need to balance fiscal stimulus with long-term debt sustainability.

Source: Trading Economics

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