The Australian dollar is higher on Tuesday morning after European leaders announced plans to establish a new treaty which imposes strict budget discipline on member states.

French President Nicholas Sarkozy and German Chancellor Angela Merkel announced plans early on Tuesday morning (AEDT) to establish a new European Union treaty by March.

The treaty would force the EU’s 17 member states to achieve budget deficits of less than three per cent of Gross Domestic Product (GDP) or face sanctions.

It is seen as a necessary step in restoring market confidence in the continent and overcoming the current debt crisis.

The announcement saw the Australian dollar climb above 103 US cents, but it lost ground after a news report suggested ratings agency Standard and Poor’s would place Germany, and five other Euro nations, on “credit watch negative”.

That indicates it may downgrade their AAA credit ratings within 90 days.

At 0700 AEDT the Australian dollar was trading at 102.76 US cents.

Westpac New Zealand senior market strategist Imre Speizer said if Standard and Poor’s confirmed the report, it would likely drive the Australian dollar lower.

“If we get that confirmed today it will probably push markets down a little bit more,” he said.

However, he said traders were primarily focused on a meeting of EU leaders on Friday.

Mr Speizer said the Reserve Bank of Australia’s interest rate announcement on Tuesday could also move the dollar.

The RBA will announce whether it will cut interest rates or maintain the current cash rate of 4.5 per cent.

Mr Speizer said the market was anticipating a 25 basis point cut so a decision to maintain the current rate would send the local currency higher.

“If you get the surprise result where there is no change you will see yields rise and the Aussie should rise with it,” he said.