06:14 AM EST, 03/04/2025 (MT Newswires) -- EUR/USD had a decent rally on Monday as investors focused on the explosive rally in European defence stocks, said ING.

That Europe needs to spend a lot more on defense now is not in doubt, wrote the bank in a note to clients. The question is, what does it mean for foreign exchange? Can European defense spending move the needle on European growth and curtail some of the European Central Bank's easing cycle?

ING's eurozone economic team doubts defense spending will have a significant impact on European growth prospects. After all, Germany has only spent around a quarter of its 100 billion euros Special Defence Fund established in 2022 after the Russian invasion of Ukraine.

The bank stated it certainly doesn't want to stand in the way of the rally of European defense stocks nor the steepening in European government bond curves, but it has doubts about the merits of buying the euro (EUR) on this narrative.

Instead, it has largely been the softening of United States data and the repricing of Federal Reserve expectations that have driven EUR/USD higher, according to ING. The Atlantic two-year spread has narrowed a "staggering" 35bps in less than a month, entirely driven by the re-pricing of the Fed. Whether this narrows any further may be a function of how U.S. equities react to the tariff news.

EUR/USD is a tough call at the moment, but looming tariffs are a real threat to an open economy such as the eurozone, pointed out the bank. If EUR/USD were to spike through resistance at 1.0535/50 for some reason, ING doubts such a rally would be sustainable.

The Swedish krona (SEK) continues to markedly outperform its G10 peers, as SEK appears the preferred way to play market optimism on a Ukraine-Russia peace deal and the boost in European Union spending, noted ING. Crucially, SEK is a high-beta currency for eurozone sentiment, and the rally in European equities is adding fuel to the krona's rally this week.

EUR/SEK is now trading close to the key 11.00 support. In the near term, a break lower is more likely than not, especially as the bank expects the ECB to reiterate a dovish stance on Thursday and Sweden's inflation data -- also released on Thursday -- is expected to show a pickup in CPIF inflation that should keep Riksbank easing expectations in check.

Beyond the short term, ING isn't convinced of lasting SEK strength. The bank expects U.S. tariffs in April to weigh on European sentiment, and a correction in equities should hit SEK more than the euro.

Incidentally, markets may be close to peak optimism on Russia-Ukraine and a "suboptimal" truce for Ukraine and the EU would weigh on SEK. The bank continues to favor EUR/SEK staying above 11.00 this summer.