By Dhara Ranasinghe and Alun John
LONDON (Reuters) -The euro and European stock futures rallied, while German Bund futures fell after the parties hoping to form Germany’s next government agreed to create a 500 billion euro ($529.80 billion) infrastructure fund and overhaul borrowing rules.
The news, which came after the close of European markets, marks a tectonic spending shift to revamp the military and revive growth in Europe’s largest economy.
The euro hit $1.0637 in the Asia session on Wednesday, its highest level in more than three months. Against Britain’s pound, the euro rose to 83.12 pence.
German and European stock futures bounced from Tuesday lows, with Dax futures up 2% in Asia trade and EuroSTOXX 50 futures up 1.5%.
"It sends a clear signal that Germany is serious about its defence, it sends a clear signal to Ukraine and at home it sends a clear signal that Germany is serious about infrastructure spending," said Berenberg chief economist Holger Schmieding.
"This is an excellent start for the new German government. This strengthens Europe and should underpin euro gains although there are trade risks to consider."
The benchmark Dax index closed down 3.5% on Tuesday on worries about U.S. tariffs.
Deutsche Bank (ETR:DBKGn) said on Tuesday it had turned more positive on the euro’s outlook following the headlines from Germany.
"The news flow is significant enough to now shift us into an outright EUR/USD bullish view," Deutsche analysts said, adding that the bank now targets the euro/dollar pair at $1.10.
European defence company shares have soared in recent days as momentum to ramp up defence spending across the region gathers pace.
But for bond markets, signs that additional spending could create more government bond issuance were expected to add upward pressure on bond yields.
Germany’s Bund futures turned sharply lower on the news and slid a further 1.1% in Asia trade on Wednesday, touching the lowest level since mid-January.
"Details around the announcement will of course be key. But this is an important step to significantly ease German fiscal policy and to start reversing years of underinvestment into the domestic economy and on defence spending," said Marchel Alexandrovich, economist at consultancy Saltmarsh Economics.
In addition, markets were processing a Reuters report that U.S. President Donald Trump’s administration and Ukraine plan to sign a much-debated minerals deal.
($1 = 0.9438 euros)