Euro rallies to three-year high versus dollar after German coalition breakthrough

The euro rose to a three-year high against the dollar on Friday as investors welcomed a breakthrough in German coalition talks.

The single currency jumped to as high as $1.2131 as it emerged that leaders of Angela Merkel's conservative Christian Democratic Union bloc and the Social Democrats have agreed to a blueprint for formal coalition negotiations.

David Morrison, chief market strategist at GKFX, said: "The news that Chancellor Merkel has managed to put together a workable coalition government has seen the single currency surge higher this morning. EURUSD has finally broken above significant resistance around 1.2100 and is currently trading at a three-year high.

"If it can hold above here going into the weekend then there’s a high probability of further gains to come which crucially means a continuation in the US dollar downtrend. This morning’s currency move has led to a rally in precious metals. However, it’s worth noting that the Dollar Index has yet to break convincingly below support around 91.00. But should this happen then the selloff in the dollar could well accelerate."

IG analyst Joshua Mahony said: "Merkel is one of the biggest proponents of the eurozone project, and her ability to remain in power will be key to ensuring stability as we go forward. While a deal is not across the line, the sands seem to be shifting in favour of a positive, stable resolution which is expected to remove a significant degree of uncertainty for euro traders."

Berenberg analyst Holger Schmieding said Germany is likely to get a new government just in time for the Easter holiday.

"All in all, German policies will not change dramatically according to what is known about the deal so far. Relative to policies that would have been pursued under the alternative 'Jamaica' coalition between Merkel, the FDP and the Greens, which foundered when the FDP walked out of such talks in November, Germany will apparently add a bit more to social spending over time and close down its coal power stations at a slower pace.

"Also, with the SPD likely to claim the German finance ministry, future negotiations about European reforms may be a bit less noisy than they might have been otherwise. In terms of substance - Germany will promote some modest EU/eurozone reforms jointly with France - the outlook does not change much, though: Germany will agree only to those reforms which Merkel can sell to the conservative part of her own base, including the Bavarian CSU."

On Thursday, the euro gained ground against the dollar as the latest European Central Bank minutes suggested that rate-setters in Frankfurt might harden their guidance for their policy settings.

According to the minutes of the ECB governing council's last policy meeting, "the language pertaining to various dimensions of the monetary policy stance and forward guidance could be revisited early in the coming year".