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Will German Court Decision Derail the Euro?

On Wednesday, investors will wait with bated breath for news from Germany again, where the Federal Constitutional Court has the power to make or break the fate of the euro zone.

The court will deliver its verdict on whether last year's Greek bailout and Germany's contribution to the euro zone rescue fund, the EFSF, were in line with the German constitution and with European Union law.

Reichstag Parliment building, Berlin, Germany
Martin Child | Photodisc | Getty Images
Reichstag Parliment building, Berlin, Germany

"Markets will happily react negatively if the decision is adverse and there will be no reaction if it is as expected," Lothar Mentel, chief investment officer at Octopus Investments, told CNBC.com.

Usually if it feels the matters brought to its attention exceed Germany's jurisdiction, the Constitutional Court will not interfere, he said.

"My gut feeling is that they will just pass the ball back to Berlin," Mentel added.

Past experience shows that the court does not avoid unpopular rulings, but this time it should not be expected to "reverse the current crisis management," Carsten Brzeski, senior economist at ING Bank in Brussels, wrote in a market note.

"In our view, the ruling will rather focus on rights and responsibilities of the national parliament, without having an ex-post impact on the ongoing rescue packages," Brzeski wrote. "Fears of a complete reversal of the measures taken so far seem exaggerated."

While not necessarily putting the rescue of indebted euro zone countries in danger, the court's ruling could contribute to making it even more difficult for the German government to save them, according to Eckart Tuchtfeld, an analyst with Commerzbank.

Parliament Position Crucial

"We do not expect the court to declare the rescue funds for highly indebted countries to be unconstitutional," Tuchtfeld said. "But it is likely to strengthen the parliament's position in its conflict with the government."

"As a result, the government may have to grant the parliament more information and control rights than it would like to in the interest of the EFSF functioning as smoothly as possible," he added.

Germany's inaction has contributed to financial markets' uncertainty throughout the crisis; since the election victory of Gerhard Schroeder in 1998, the country lost its unconditional pro-European stance it had adopted since the end of the war, Brzeski noted.

Even so, Chancellor Angela Merkel should have never tolerated or even, sometimes, encouraged the feast of Greece-bashing that started after it became apparent that the periphery euro zone country needed help, Schroeder told CNBC in an interview late Monday.

"She was just too populist at the beginning and now she can't," backpedal, Mentel said.

The current government will not push for a break-up of the euro zone but it will not embrace a joint euro zone bond or a political union either, according to analysts.

The common euro bond, seen as a silver bullet in some countries, is loathed in Germany because of the moral hazard it implies – the fear that, once all euro zone countries will be able to raise capital at the same cost, there will be no incentives for them to boost their fiscal discipline, Mentel explained.

"You need to make the cost of public deficits cheaper, but be careful that they [big spenders] don't fall back into their own way," he said.

However, politicians will "muddle through" with boosting the EFSF and will slowly advance towards a common euro bond, as they understand the benefits of the euro and the European Union and that their fate ultimately lies with Germany, according to analysts.

"This is the biggest responsibility they had in 60 years. It's frightening," Mentel said.

Corrected:This version of the story makes clear the Court's decision is due on Wednesday, not on Thursday.

Contact Europe: Economy

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