Euro Surges vs Pound, Dollar as Germany Opens Spending Floodgates

March 5, 2025 - Written by David Woodsmith

STORY LINK Euro Surges vs Pound, Dollar as Germany Opens Spending Floodgates

A dramatic German U-Turn on defence and infrastructure spending has triggered a Euro surge in global markets. In contrast, the UK government has indicated that UK spending plans will have to be scaled back.

EUR/USD has jumped to 16-week highs above 1.0700 with the dollar also struggling in global markets.

Scotiabank noted that the Euro is still below fair value and added; “There is some runway for the EUR to strengthen.”

The Pound to Euro (GBP/EUR) exchange rate has posted sharp losses to 2-week lows just below the 1.2000 level.

Incoming Chancellor Merz and the CDU-CSU have agreed a deal with the SPD on additional defence and infrastructure spending.

Defence spending above 1% of GDP will be excluded from the debt brake and there will be a special fund to boost infrastructure spending by EUR500bn over the next 10 years.

According to Citigroup; “The latest announcements from the EU, and Germany in particular, exceeded expectations of the size and scope of fiscal pledges towards defence.”

Robin Winkler, chief economist at Deutsche Bank Research commented; "Pending more clarity on this issue, and being mindful of some execution risk, we believe this is one of the most historic paradigm shifts in German postwar history."

George Saravelos, Deutsche’s global head of FX strategy added “Europe and Germany in particular are showing a historically unprecedented responsiveness to revising the fiscal stance. This flexibility will not only likely mute the potential impact of upcoming tariffs but creates an upside growth bias once the impact of tariffs has been absorbed.”

Credit Agricole added; “The latest developments make us more constructive overall and if sustained may mean that we have to bring forward some of the euro strength.”

The plans will need to be approved in parliament and the AfD is likely to oppose the move, but MUFG commented; “extraordinary developments in recent days likely provides cover for Merz to justify the action.”

ING noted the importance of budget spending, but also focussed on monetary policy; “In FX markets, we normally look at the combination of looser fiscal and tighter monetary policy as currency positive. The slight problem for the EUR/USD story here is that the fiscal news has not moved the needle on European Central Bank policy expectations.”

There are strong expectations that the ECB will cut interest rates again this week, curbing Euro yield support.

As far as the UK is concerned, government sources have indicated that the £9.9bn fiscal headroom stated in the Autumn fiscal statement has been eroded by domestic and global developments.

There have also been indications that welfare spending will be a target for spending cuts to meet the fiscal rules.

Expectations of a tighter fiscal policy will lead to a downgrading of growth forecasts.

The government could adjust fiscal rules, but this would risk undermining market confidence.

As far as the Bank of England is concerned, comments from Governor Bailey and other MPC members will be monitored closely in testimony to the Treasury Select Committee later Wednesday.

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TAGS: Euro Forecasts Euro Dollar Forecasts Euro Pound Forecasts