European shares hit a 14-month high on Wednesday after Germany's top court allowed the ratification of the euro zone's new bailout fund under some conditions, with analysts saying that the market had potential to move substantially higher from here.

The court said Germany could ratify the European Stability Mechanism (ESM) and budget pact as long as it could guarantee there would be no increase in German financial exposure to the bailout fund without the parliament's approval.

Approval of the ESM is a vital part of a European Central Bank plan to defuse the debt crisis by buying struggling peripheral countries' bonds in the secondary market. Shares have surged about 10 per cent since ECB President Mario Draghi pledged in July to take all necessary steps to protect the euro zone.

"It's a confirmation that Germany is engaged in the project to rebuild and reconstruct Europe. There is a kind of Draghi economics going on. There is a clear receding risk of a euro break up and people are readjusting their portfolios," said Didier Duret, chief investment officer at ABN-Amro Private Banking, which manages more than $200 billion.

ABN-Amro adjusted its portfolio on Friday to have an "overweight" stance on global equities by mostly investing its cash holdings to buy European financials and industrials.

It changed its stance to became "neutral" on European financials from "underweight" and strengthened its "overweight" position on industrials. Its balanced portfolio now accounts 46 per cent bonds, 35 per cent equities and 6 per cent cash.

Duret saw an 8 to 10 per cent upside potential for the euro zone's blue chip Euro Stoxx 50 index by the end of the year. The index was up 0.8 per cent at 2,577.60 points.

Analysts at Goldman Sachs also said markets could rise from current levels, thanks to policymaker support, but were unlikely to do so if economic data failed to show signs of improvement.

At 1112 GMT, the FTSEurofirst 300 index of top European shares was up 0.3 per cent at 1,109.93 points after rising as far as 1,115.90, its highest since July 2011.

Germany's DAX was up 0.7 per cent, Spain's Ibex rose 0.8 per cent and Italy's FTSE MIB gained 1.1 per cent following the German court ruling.

"It's all good news. The fear was they were going to say 'nein', so the 20 per cent down in the market that we could have had is off the table," Gerard Lane, equity strategist at Shore Capital, said.

"The conditionality is quite light. The big statement to my mind was that the ESM is not against the German constitution."

When it comes into effect, the ESM will be a 700 billion-euro firewall against the spread of the three-year-old debt crisis. Only German ratification is still pending.

CYCLICALS LEAD

Cyclicals were in demand on expectations the court ruling would help in tackling the long-running euro zone debt crisis and bring the region's economy back onto a recovery path.

The STOXX Europe 600 banking index advanced 1.3 per cent, insurers gained 1.2 per cent and autos rose 1.1 per cent and tech shares were up 1.3 per cent.

"In all, another plank of uncertainty looks to have been removed. That said, all eyes now move to the Dutch elections, whilst Greece continues to bubble in the background," Keith Bowman, equity analyst at Hargreaves Lansdown, said.

Mainstream pro-European parties looked set to dominate the parliamentary election under way in the Netherlands, dispelling concerns that radical eurosceptics might gain sway in a core euro zone country and push to quit the European Union or flout its budget rules.

Investors also focused on a two-day US Federal Reserve policy meeting starting on Wednesday. Markets widely expect some type of new monetary stimulus to boost the US economy.

Equities have rallied strongly since June, with the euro zone's blue chip Euro Stoxx 50 index surging more than 25 per cent, lifted by expectations of central bank action to revive economic growth and tackle the euro zone debt crisis. – Reuters