European shares, euro gain as Greek fears ease

(Reuters) - European stocks rose for a third straight session on Monday and the euro bounced back from two-year lows, as Greek polls showing growing support for pro-bailout parties eased speculation about a disorderly exit by Athens from the single currency.

But the gains were seen as vulnerable to developments in Spain, where the government's borrowing costs rose sharply as investors factored in the impact of fixing the troubled banking sector on the government's finances.

Global share markets, commodities and the euro are largely recovering from the sharp falls of last week, when investors fled to the safety of the U.S. dollar on mounting concerns about Greece's future and Spain's banking sector, and after some disappointing economic data from Chinaand Europe.

The recovery was boosted by the publication of five Greek polls on the weekend which showed the conservative New Democracy party, a supporter the bailout plan, with a slight lead over the anti-bailout leftist SYRIZA party, although analysts said the outcome of the June 17 election was still too close to call. [ID:nL5E8GQ2CK]

"Anything that allays fears over Greece is a positive. People are just looking for a bit of respite," said Bastion Capital's head of equities Adrian Slack.

The FTSE Eurofirst index of top European shares extended its gains of last week, rising 0.5 percent to 989.99 points, but was still on track for its biggest monthly loss since an August selloff last year.

The easing speculation of a disorderly exit by Greece from the euro zone also helped the MSCI world equity index gain 0.4 percent to 301.43.

The euro edged up 0.5 percent to $1.2580, pulling away from Friday's level of $1.2495, its lowest since July 2010. But after last week's sharp falls, the single currency remains on track for its worst month since last September.

Any recovery in the single currency looked limited by the high numbers of leveraged investors in the foreign exchange market holding euro bearish bets, as revealed by data for the week to May 22 released by the U.S. Commodity Futures Trading Commission (CFTC).

"Heading into the Greek elections we'll fluctuate a lot. Because the market is very, very short euro, reactions to any positive news may be bigger than those to negative news," said Mitul Kotecha of Credit Agricole Corporate and Investment Bank.

SPAIN AGAIN

Just as speculation rose that Greece can stay part of the single currency zone, the outlook for Spain worsened as it tried to get to grips with its ailing banking sector.

A government source told Reuters on Sunday Spain may recapitalize its fourth-largest lender Bankia, which last week asked for rescue funding of 19 billion euros ($24 billion), using new government bonds in return for shares.

The report sent the premium investors require to hold Spanish government bonds over their German counterparts up 13 basis points on Monday to 510 bps, the highest since the euro was launched.

Spanish 10-year government bond yields also jumped 14 bps to 6.49 percent, their highest since November, while equivalent Italian government bond yields followed suit, gaining 3 bps to 5.84 percent.

Spain's Prime Minister Mariano Rajoy said only that the government is currently studying how best to inject public funds into its troubled banks, adding that there had not been any talks with the European Central Bank over recapitalizing Bankia.

The unorthodox plan to recapitalize Bankia by issuing sovereign debt, if true, has served to heighten worry that, in trying to fix its banking system, the government will worsen its own balance sheet.

"I don't believe transferring the bad assets of the bank onto the sovereign is in any way a good idea," said Brenda Kelly, senior strategist at CMC Markets.

Bankia shares fell 26.8 percent as trading resumed after being suspended on Friday, before the bank asked for a 23.5 billion euros bailout.

"When you think about 24 billion (euros) for one bank you could be looking for anything upwards of 60 billion to a 100 billion if it all falls apart," she said.

CHINA HOPES

Commodity markets, already firmer on the prospects pro-bailout parties may succeed in the Greek election and the resultant easier tone in the U.S. dollar, also gained a boost from hopes China may take steps to boost its flagging economy.

A government official told Reuters on Monday China will soon resume paying subsidies to rural residents who trade in old vehicles for new ones in an effort to rekindle demand in the world's largest auto market.

Three-month copper on the London Metal Exchange rose 1.2 percent to $7,731.75 a tonne, recovering from falls of 8 percent this month.

Brent crude oil gained for a third session to be over $107 per barrel. The price was also affected by Middle East oil supply concerns as talks over Iran's nuclear program faltered. U.S. crude oilfutures also rose more than $1 to a high of $91.92.

Spot gold rose 0.4 percent to $1,580.42 per ounce, its highest level in nearly a week, in tandem with other risk assets.

Investors were also looking ahead to major economic data due from the United States this week which includes consumer confidence, gross domestic product and, on Friday, the May non-farm payrolls report, which could provide clues on whether the economy is running out of steam or has simply hit a soft patch.

"Data this week will reveal further contrasts between the U.S. and euro zone," said Credit Agricole's Kotecha.

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