06:41 AM EST, 02/26/2025 (MT Newswires) -- The euro (EUR) is continuing to trade on a stronger footing following the German parliamentary election results at the weekend, said MUFG.

It has helped to lift EUR/USD back above the 1.0500 level with the pair close to recent highs at around 1.0530, wrote the bank in a note to clients.

The euro was supported Tuesday by a Bloomberg report stating that the CDU/CSU parties are discussing plans with the SPD for debt-financed defense spending of up to 200 billion euros with the goal of securing approval in the current parliament before the new legislature is sworn in next month. New Prime Minister in waiting Friedrich Merz told reporters Tuesday that "we are talking to each other, but it's much too early to say something" while adding that "right now, I view it as very difficult."

Without the required two-thirds majority in the new parliament, the mainstream parties don't have enough votes to make changes to Germany's constitutional borrowing limit, pointed out MUFG. But the CDU/CSU and SPD who are expected to form the next coalition government could get around that by attempting to secure lawmaker approval before the Bundestag meets for the first time at the end of March, possibly with the support of the Greens.

One idea reported under discussion would be another special fund to finance new military spending and aid for Ukraine. Other options could be to expand the existing 100 billion euros fund for armed forces or tweak the debt brake to allow for additional defense spending but those measures would require a two-thirds majority in parliament. Merz stated Tuesday that "it's out of the question that we will reform the debt brake in the near future. If it happens at all it will be quite complicated and difficult task."

The prospect of additional government spending/borrowing in Germany has contributed to the recent underperformance of Bunds, added the bank. The yield spread between 10-year German and United States government bonds has narrowed by around 30 basis points since early this month, and reached the narrowest level since October before the U.S. presidential election.

A development that is helping to provide more support for the euro against the US dollar (USD), according to MUFG.