By Harry Robertson

LONDON (Reuters) - The biggest three-day rally in the euro in over two years has sent analysts scrambling to rewrite their forecasts for the currency, as a surge in European spending and signs of a weakening U.S. economy dampens chatter about a fall to $1.

Deutsche Bank has said it is now "bullish" on the euro after being "bearish" only last week. Rabobank and MUFG have shifted to more upbeat calls after previously warning about a drop to parity, while Nomura has recommended buying the euro against the pound.

The single currency powered higher on Wednesday after the parties hoping to form Germany's next government agreed to overhaul the long-standing debt brake borrowing rules in a tectonic shift in the country's politics.

The euro has now risen 3.1% over the last three days - its biggest such rally since November 2022 - to $1.07, its highest in four months.

"I don't see the euro breaking below parity, the game has truly changed," said Tim Graf, head of macro strategy for EMEA at State Street Global Markets. "But I don't expect a move above $1.10 unless there's a super great deal for Ukraine."

Tariffs are still a major threat, but analysts think the impact will be cushioned by a rise in spending on security that has sent defence stocks surging in recent days. A potential peace deal in Ukraine could also reduce European energy costs and boost growth.

EUROPE SPENDS BIG

The trigger for the latest jump in the euro was the German plan to exempt defence spending above 1% of GDP from its so-called debt brake, which has limited spending since 2009, and create a 500 billion euro ($535 billion) infrastructure fund.

"It is a surprise," said Dominic Schnider, head global FX & commodities at UBS Global Wealth Management’s chief investment office. "With that kind of support, the need to go to parity is lessened. You now have a counter-element to the tariffs."

The European Commission proposed on Tuesday to borrow up to 150 billion euros to lend to EU governments under a rearmament plan, as other countries plan to boost defence spending as U.S. President Donald Trump pauses support for Ukraine.

"Re-arming is re-assertiveness, which is good for the currency," said Macquarie Group strategists Thierry Wizman and Gareth Berry in a note.

"(It) would spur economic activity, allow some reflation, and cause the ECB to reconsider the extent of its policy rate cuts going forward. That, too, is good for the euro."

Germany's 10-year bond yield - the benchmark for the euro zone - surged by the most in one day since the late 1990s on Wednesday, up 23 basis points, as investors braced for a jump in borrowing through debt markets. Yields move inversely to prices.

Higher yields make investing in European fixed income more attractive compared to the United States, boosting demand for the euro against the dollar.

U.S. GROWTH SLOWS

On the dollar side of the equation, tepid U.S. data has also recently knocked the U.S. currency and highlights how companies and investors are increasingly worried that tariffs will hurt the American economy.

Trump put 25% tariffs on Mexico and Canada this week and increased levies on China.

The U.S. dollar index, which tracks the currency against six others, hit its lowest since November on Wednesday at 104.85.

"The return of U.S. growth concerns has clearly been a drag on the U.S. dollar in recent sessions," said Jane Foley, senior FX strategist at Rabobank. "The change in the fundamental drivers behind the euro have been even more dramatic."

Foley said she sees the euro staying around $1.07 over the next month.

Analysts warned trade measures were still a risk. Trump last week floated slapping 25% tariffs on the European Union and his administration has said April 2 is a date to watch.

Schnider at UBS said: "Do I think there's a little bit of an exaggeration going on in the exchange rate right now? Absolutely, there's still the tariffs."

($1 = 0.9358 euros)

(Reporting by Harry Robertson, additional reporting by Dhara Ranasinghe; Editing by Amanda Cooper and Toby Chopra)