06:56 AM EST, 03/06/2025 (MT Newswires) -- The euro (EUR) has surged higher over the last couple of days, rising back above 1.0800 against the US dollar (USD) ahead of Thursday's European Central Bank policy meeting, said MUFG.

The German fiscal package, alongside the European Union's plans to step up defense spending amongst members, have been a game changer for the performance of the euro, wrote the bank in a note to clients.

The additional government spending will help to initially dampen downside risks to growth in the eurozone this year from trade disruption, with United States President Donald Trump planning to announce significant tariff hikes in the coming months that could hit the European economies hard, stated MUFG.

Beyond the near-term, looser fiscal policy should support a stronger economic recovery from next year onwards, pointed ut the bank. While it's still early days for the ECB to fully incorporate these plans into its outlook for policy at Thursday's policy meeting, given the legislation hasn't yet been passed, it should have a "significant" impact in the coming years.

The eurozone rate market has already reacted accordingly to price in a more hawkish path for the ECB's policy rate, added MUFG. The two-year euro-zone government bond yield has risen by around 30bps as market participants have scaled back expectations for the ECB's policy rate to move below 2.00%.

With fiscal policy expected to play a bigger role going forward in supporting the eurozone economy, it will reduce pressure on the ECB to lower rates below neutral territory, which President Lagarde has stated recently is estimated at around 1.75% to 2.25%. It fits with MUFG's own forecast that the ECB will lower rates to 2.00% this year but not below.

The bank will also be watching closely on Thursday to see if the ECB delivers a more hawkish rate cut by signaling that they may skip cutting rates at the next policy meeting in April. The eurozone rate market is less convinced now that the ECB will deliver back-to-back rate cuts on Thursday and in April.

There is currently around 35bps of cuts priced in by April. A stronger signal over a potential skip in April could reinforce the euro's upward momentum on Thursday alongside any tentative indication from the ECB that room for rate cuts will be curtailed by updated fiscal plans, according to MUFG.