The constitutional court rejected an injunction against the European Stability Mechanism (ESM), allowing Germany to ratify the fund as long as it can guarantee there will be no increase in German financial exposure to the fund without parliament's approval.
The verdict was broadly as expected and the positive reaction in Spanish and Italian debt was limited by the scale of the rally in the weeks since the European Central Bank pledged to buy peripheral debt to lower sovereign borrowing costs. The Spanish 10-year yield was down 10 basis points on the day at 5.63 percent, compared with 5.71 percent before the ruling. In late July, the yield hit an unsustainable 7.8 percent.
The equivalent Italian yield was down 6 bps at 5.04 percent. The participation of the euro zone's rescue funds is a key condition of the ECB's support, and its approval removes a potentially major obstacle to resolving the debt crisis.
"From a market point of view it gives some certainty that it will continue down the route that has been started and it doesn't throw everything into chaos," said Elizabeth Afseth, strategist at Investec in London.
However so grave were the potential consequences of the court ruling against the ESM, some caution had been priced into core markets and German Bund futures hit a session low of 139.46, down 92 ticks down on the day.
BUND SUPPLY
Later on Wednesday, Germany will launch a new October 2017 bond. Germany struggled to generate bids for a new 10-year bond last week, but the shorter maturity and perceived good value relative to similar existing debt was likely to ensure a stronger sale this time round.
"The attractiveness of the new Bobl is related to the shape of the German sovereign curve, which has the highest slope in the three- to five-year segment," said ING strategist Alessandro Giansanti in a note to clients.
Reuters pricing data showed the bond, which will carry a 0.5 percent coupon, was trading in the pre-issue grey market at a yield of around 0.62 percent.
Italy sold 9 billion euros of 12-month treasury bills at a gross yield of 1.692 percent, its lowest since March 2012.
Investors will also be watching Dutch elections to gauge the likelihood of the Netherlands remaining committed to austerity targets. Polls show the two main pro-European parties tied and, while a coalition is likely, questions remain over how quickly a new government can be formed.