Germany’s highest court has cleared the way for ratification of the eurozone bailout fund but capped German contributions and fired a cannon shot across the bows of the European Central Bank.

Markets breathed a sigh of relief across the world after the Constitutional Court in Karlsruhe ruled that the European Stability Mechanism (ESM) and the EU’s Fiscal Compact are compatible with the country’s Basic Law.

The euro surged to a four-month high of $US1.29.

‘‘This is a good day for Germany and a good day for Europe,’’ said Chancellor Angela Merkel. ‘‘Germany is fulfilling its full responsibilities as the biggest economy and a trusted partner in Europe.’’

The European Parliament leapt to its feet in thunderous applause as the news came through, the verdict removing the final hurdle blocking deployment of the 500 billion euros bailout fund and consummating Europe’s grand plan to hold monetary union together.

Yet it was a double-edged ruling, with plenty of cheer for the 37,000 citizens who had filed complaints in an outpouring of civic protest, including the neo-Marxist Left Party, the More Democracy movement and a core of eurosceptic professors.

In keeping with rulings on the Lisbon Treaty and earlier rescues, the eight judges issued a ‘‘Yes, but’’ verdict, imposing constraints that greatly reduce Berlin’s room for manoeuvre in the future.

Mrs Merkel had lost control over EMU rescue policies, according to Die Welt. ‘‘Berlin no longer dictates the terms,’’ it said.

The court capped Germany’s ESM share at 190 billion euros and ordered the government to ‘‘express clearly that it cannot be bound by the Treaty’’ if the limit is breached.

This stops the ESM increasing Germany’s share if Spain and Italy seek top-up funding.

‘‘The cap could prove a real obstacle,’’ said Raoul Ruparel from Open Europe. Volker Beck from the German Greens said the court had crippled the ESM, while Leipzig law professor Christophe Degenhardt said the eurosceptics had pulled off a coup. ‘‘Their main objective has been achieved,’’ he told Der Spiegel.

The ruling kills off hopes of a banking licence for the fund so that it can boost its firepower by tapping the ECB, calling this ‘‘incompatible with the prohibition of monetary financing’’.

Italian premier Mario Monti, the International Monetary Fund and Washington all argue that an ESM banking licence is crucial.

The Karlsruhe court said both houses of the German parliament - including the eurosceptic Bundesrat - must be consulted on all EU bailouts.

The Bundestag ‘‘must individually approve’’ every big rescue package and is ‘‘prohibited from establishing permanent mechanisms based on international treaties which are tantamount to accepting liability for decisions by free will of other states, above all if they entail consequences which are hard to calculate’’.

This bans eurobonds, debt-pooling or fiscal union under the existing Basic Law. Any alienation of the Bundestag’s budgetary powers would require a new constitution and a referendum.

‘‘This is the key clause,’’ said Hans Redeker from Morgan Stanley. ‘‘The court’s ruling is ’back-loaded’. The consequences will hit later. For now we are living in a monetary paradise with the ECB ready to do some heavy weightlifting, so we think risk assets will continue to rally until Christmas. Then be careful.’’

The ruling stipulates that no ESM package for Spain and Italy can go ahead without a vote in the Bundestag, where bailout fatigue is palpable.

‘‘The political fall-out is a key risk,’’ said Michael Michaelides from RBS. ‘‘Even stricter conditionality could deter these countries from requesting assistance until they are forced to by escalating bond yields.’’

Under the complex deal between Chancellor Merkel and ECB chief Mario Draghi, the central bank cannot intervene in the bond markets of each country until they request a rescue and sign a ’Memorandum’ ceding fiscal sovereignty to an EU-IMF ’Troika’.

Spanish premier Mariano Rajoy seems determined to tough it out now that Spain’s two-year bond yields have plummeted 2.68 per cent, down from 6.5 per cent since the Draghi Plan began to emerge in July.

‘‘It is completely out of the question that we are going to request a rescue,’’ he said yesterday, insisting that economic recovery is on the way. ‘‘I still don’t know what the conditions are and whether a rescue is needed. We are going to watch the bonds spreads,’’ he told Spain’s parliament.

Andrew Roberts from RBS said markets will test this eccentric policy as key bond auctions approach in October. The stock market rebound has a circuit-break built into it.

‘‘We think the rally will last another two to three weeks at most,’’ he said.

The big surprise in the court ruling was a glancing comment on the Draghi Plan, a hint of things to come when the judges grapple with that issue early next year.

‘‘An acquisition of government bonds on the secondary market by the ECB aiming at financing the Members’ budgets independently of the capital markets is prohibited, as it would circumvent the prohibition of monetary financing,’’ the ruling said.

Germany’s judges are holding a tight leash and pulling it tighter with each successive ruling.

Telegraph, London