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Europe Finally Gets Its ‘Bazooka’; Markets Rally

Europe cleared a number of major hurdles in its quest to find a comprehensive solution to the euro zone debt crisis on Wednesday, with a German court giving its heavily-anticipated approval for a new rescue fund and the unveiling of new proposals for a European banking union and more European integration.

Caroline Purser | Photographer's Choice | Getty Images

The German Constitutional Court ruled that Germany, which contributes more than 25 percent to the 500 billion euro fund know as the European Stability Mechanism, or ESM, can ratify it. It attached conditions to Germany's participation however, saying the government needs to get approval of the lower house of parliament, for example, if Germany's exposure to the ESM exceeds 190 billion euros ($245 billion).

European stocks reached multimonth highs and the euro rose to a four-month high following the ruling.

“Within less than a week, the euro zone has finally received its long sought-after impressive bazooka: Conditional, but unlimited, ECB bond purchases, and the ESM which provides a new fresh lending capacity of 500 billion euro,” Carsten Brzeski, senior economist at ING said in a research note.

A negative ruling would have jeopardized the future of the ESM and thrown a curve ball at the single currency.

It would have also backfired on the ECB's plans to intervene in the debt markets to lower debt costs, John Noonan, senior foreign-exchange analyst at Thomson Reuters, told CNBC Asia’s “Squawk Box” before the ruling was announced.

The euro has risen almost 7 percent since late July when the European Central Bank’s (ECB) President Mario Draghi calmed panic-stricken markets by pledging to save the euro area from collapse. Draghi followed that by outlining plans last week to buy bondsof troubled euro zone states.

“Euro zone governments have now received more time to do their homework, implement reforms and austerity measures. Today's ruling has not solved the crisis, neither has last week's ECB decision. However, after monetary and legal authorities have done their part, the destiny of the euro zone is now exclusively in the hands of governments,” ING's Brzeski said.

That puts the spotlight firmly on Spain, which on Wednesday continued its opposition to a bailout request, despite huge funding needs for its banks and highly indebted regions. (Prime Minister Rajoy hinted to a Finnish newspaper that he may seek help for the country anyway.)

Analysts still believe the country will need to seek aid.

“Spain needs external financial support — a view that is now clearly held by the consensus. A swift and smooth move by Spain to request external support is needed to validate the recent improvement in market sentiment towards Spain (and an improvement in financial markets more broadly),” Goldman Sachs said in a research note on Wednesday.

A Vision for the Future

Looking beyond the immediate problems facing the euro zone, European Commission President Jose Manual Barroso earlier on Wednesday outlined a new plan for a European banking union and said he the bloc should move towards a “federation of states” to tackle the region’s common problems.

That would ultimately require a new treaty, which could be subject to referenda in a number of member states, a long and complicated process. The Commission will present ideas for changes to the existing treaty before 2014, he said.

Analysts agreed, however, that more integration was probably needed to save the euro and create a viable currency union.

“When you see the comments from the U.S. and from Asia it’s the same direction — they want to see Europe operate as one big ship. Because what’s happening now is not only posing a big threat to the European economy but to the global economy, if we see a very uncoordinated disintegration of the euro,”Karsten Schroeder, CEO of Amplitude Capital, told CNBC. “So I think given the situation we’re in, we need more European leadership, we need more power to the central European organizations, otherwise we cannot solve this crisis.”

Barroso outlined proposals to move towards a European banking union, under which the ECB would monitor all euro zone banks.

"This new system, with the European Central Bank at the core and involving national supervisors, will restore confidence in the supervision of all banks in the euro area," Barroso said in a statement released by the European Commission. "We want to break the vicious link between sovereigns and their banks. In the future, bankers' losses should no longer become the people's debt, putting into doubt the financial stability of whole countries."

Barroso wants the European supervisor in place by the start of next year.

“An EU banking union is necessary to solve the euro crisis,” Tom Elliott, global strategist at JPMorgan, told CNBC. “It will lower the risks of having to deal with another type of systemic failure in the banking system.”

Contact Europe: Economy

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