Can the euro continue to power ahead?

The rise in German bund yields has been bigger than anything we have seen since German reunification some thirty-five years ago. Does this suggest that the huge volte-face from Germany on its debt brake, plus other efforts to lift investment and growth are as significant as what happened between East and West Germany all those years’ ago? Another blast from the past came from new German Chancellor Merz. He said that the country will do “whatever it takes” to bolster defence spending in the country. The words are significant, and presumably ‘meant’ because they evoke memories of former ECB President Draghi’s speech back in 2012 that the bank would do whatever it takes to save the euro. His comments did seem to save the euro as the eurozone debt crisis came to an end and the euro soared. German reunification also caused dramatic currency consequences as the German deutschemark (there was no euro back then) surged.

In short, if we do consider these German and EU announcements to bolster defence spending and loosen the fiscal shackles to be as seismic as German reunification or the ‘saving’ of the euro, we might expect the currency to rise just as dramatically. The FX market has clearly made a good downpayment on such a rally as the euro is already up some four cents against the US dollar in the last week, which is a big move for a currency that has essentially been asleep  since late 2022. The key questions, of course, are as follows. Are these fiscal moves from Germany and the EU really seismic? And, if so, could they cause this rally in the euro to become both dramatic and long-lasting?

In theory, the first way to test this is to look at the size of the fiscal packages on offer, although this is still to be calculated as more countries chip in with increased defence spending. We say, ‘in theory’, for while this package is really not on a par with what Germany spent on reunification, it is immeasurably bigger than when Draghi ‘saved’ the euro - as that cost nothing. So far it looks as if the EU/German packages could add up to around EUR2tr in extra fiscal room for defence expenditure and other fiscal measures. That’s over 10% of the EU’s GDP. That’s big, if not as big as the fiscal effort made during German reunification. That too has been costed in the EUR2tr range but Germany’s economy is only around a quarter of the EU’s and hence, in proportionate terms the current German/EU package is much smaller.

However, it comes to the euro, size does not matter, as Draghi managed to rescue the euro with a plan to buy stressed euro zone bonds (termed Overnight Monetary Transactions) that the ECB never had to uutilize, as the market did the ECB’s work by purchasing bonds and purchasing the euro. With these two seismic events in mind, the key today seems to be whether a combination of the size of the EU/German plan and the psychological impact of the EU’s fiscal awakening is sufficient to maintain euro strength.

This being said, we always have to bear in mind that the euro does not live in a vacuum that only contains EU and German fiscal influences. Other factors have a bearing on the euro and, at the moment, these other factors are very noisy indeed; especially those coming from the US and Ukraine. Where does all this leave us? It certainly leaves us more bullish for the euro than we were before all these fiscal announcements. But it is on a par with seismic events like German reunification or Draghi’s OMT? Not in the Standard Bank’s view. Hence, it cannot expect the euro to continue surging in the way it has done recently. In short, euro/dollar has managed just over 50% of the rise it expects to see this year inside the first three months, but the other 50%, or so, may take the rest of 2025.