A ruling by Germany's Constitutional Court later on Wednesday on the legality of euro zone's permanent bailout fund presents the next hurdle for a resurgent euro - the single currency has seen its fortunes turn around in just two months on hopes of an end to the region's debt crisis.
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 bonds of troubled euro zone states - helping take the euro to a four-month high against the dollar on Wednesday at $1.2885 (Exchange:EUR=) .
Germany's Constitutional Court will rule on whether the European Stability Mechanism's (ESM), terms breach the German constitution and on a new pact that could force euro zone governments into strict budgetary discipline.
The ESM was due to take effect in July as a backstop to protect the debt crisis from spreading by providing loans to troubled euro zone members. It is designed to replace the European Financial Stability Facility, which has backed bailouts for Greece, Portugal and Ireland. Germany, which contributes more than 25 percent to the 500 billion euro ESM needs to ratify the bailout fund for it to succeed.
Any ruling that threatens the future of the ESM could throw a curve ball at the single currency.
"The euro has had a dream run ever since Draghi proclaimed that the ECB would do whatever it takes to save the euro. It has been trending higher across the board, so it would be a huge momentum change if they (the Constitutional Court judges) rule in a negative way about the future of the ESM," John Noonan, Senior FX Analyst at Thomson Reuters, told CNBC Asia's "Squawk Box" on Wednesday.
"That would totally backfire on all the plans the ECB has in their intervention policy, so it is a very important decision," he added.
The ECB has said it will buy the government bonds of those countries under financial pressure only if they apply to the bailout fund for support first.
Both Italy and Spain have been pressured by high borrowing costs this year and when yields on Spanish bonds surged above 7 percent in July, the euro fell to two-year lows against the dollar as panic gripped financial markets. That was when Draghi stepped in with tough talk.
Currency analysts said a positive outcome from the German Court ruling was priced into the markets, so only a negative surprise would derail the euro rally.
"If the Court somehow rules against the ESM, puts in some kind of caveat or delays the ECB plans to buy bonds, then the euro would lose momentum and fall quickly but I don't see that happening," said Noonan.
Olivier Desbarres, Head of FX Strategy at Barclays told CNBC he expected the German court verdict to be just a small barrier to euro gains.
"The court has a lot of gravitas, so the markets will be looking at the ruling closely. But I think this is just one small hurdle in a long-drawn process, which ultimately ends up with the ECB buying Spanish or other peripheral countries' bonds," he said.
Even if there are caveats to the court's ruling on the bailout fund, they are unlikely to derail the process that appears to be in place to end the bond crisis and that means the outlook for the euro remains positive, currency analysts said.
"There has been a rapid rebound in the euro from $1.21 all the way up to $1.28. Clearly the market is taking Draghi seriously and it is also expecting quantitative easing from the Fed, so there is more room to rally," he added.
The U.S. Federal Reserve concludes a two-day meeting on Thursday and is widely expected in financial markets to deliver a third round of quantitative easing or asset purchases to boost a fragile economy.
-By CNBC's Dhara Ranasinghe
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