The euro surged for the second consecutive trading day amid the EU’s plan to boost defence spending by hundreds of billion euros.
The euro surged for the second consecutive trading day after Germany’s Chancellor-in-waiting Friedrich Merz said the government would unlock billions of euros for defence and infrastructure spending. The announcement aligned with European Commission President Ursula von der Leyen’s proposal to activate €800 billion in defence funding following US President Donald Trump’s decision to halt aid to Ukraine.
Europe to discuss mobilising funds for defence
On Tuesday, von der Leyen said the EU plans to bolster Europe’s defence and military spending by activating a mechanism to mobilise €800 billion in special funds, stating that Europe is “in an era of rearmament” and is “ready to massively boost its defence spending.” This announcement came after Washington suspended all military aid to Ukraine on Monday.
The proposal will allow member countries to raise their defence spending “without triggering the excessive deficit procedure,” she referred to the 3% Gross Domestic Product (GDP) deficit threshold. The commission calls for member states to increase their defence spending by 1.5% of GDP on average, unlocking €650 billion over the next four years. It has also proposed extending the €150 billion in loans, making a package to €800 billion to boost the bloc’s expenditure. The proposal is yet to be discussed at a summit attended by the 27 national leaders in Brussels on Thursday.
Among EU member states, Germany faces constraints on fiscal spending due to the “debt break” law enacted in 2009, which limits the government budget deficit to 0.35% of GDP. Merz announced a plan to increase defence spending beyond 1% of GDP and can be exempted from the debt break. He said Germany needs to do “whatever it takes” to defend the country. His conservative party and the SPD, currently in coalition talks, have also proposed a €500 billion special fund for infrastructure investment.
Germany’s announcement to increase defence spending is seen as a major push for the continent to urgently ramp up military budgets ahead of Thursday’s summit. However, France and Italy may struggle to boost their spending due to limited fiscal capacity.
In addition, the European Investment Bank is set to propose expanding its mandate to finance projects dedicated to military use, according to a Bloomberg report. The bank has a balance sheet of €600 billion but is currently only permitted to fund projects with both civilian and military applications.
Euro hits a three-month high
The euro rose to above 1.06 against the US dollar on Tuesday, hitting the highest level since 12 November 2024. The pair surged more than 2 US cents in the last two trading days, alongside all-time highs in the European stock market, suggesting growing investor confidence in the bloc’s economic outlook amid plans to bolster defense spending. Germany’s potential fiscal policy shift has further strengthened optimism about its economic recovery.
European government bond yields have also surged. Germany’s 10-year bund yields stabilised at 2.48% after a 9-basis point rise the previous day, while the French 10-year government bond yield rose to 3.23%, reaching a one-week high on Tuesday. “This comes as the market braces for a sizeable increase in defence spending, and ramping up of issuance to fund it,” Michael Brown, a senior research strategist at Peperstone, wrote in a note.
The British Pound also soared over the past two trading days against the dollar, mirroring similar political and economic dynamics, as the UK’s gilt yield climbed.