European shares rose on Tuesday on optimism the European Central Bank's (ECB) move to inject cheap cash would help banks manage their balance sheets, with equities seen gaining about 5 percent in three to six months on improving liquidity and economic data.

Fund managers said investors should gradually buy more cyclcial shares to reap attractive returns as sentiment was improving, the pace of global economic recovery was gaining momentum and a euro zone credit crunch has almost been avoided.

Investors focused on the ECB's second offering of cheap three-year loans, with a poll predicting it was expected to allot 500 billion euros ($670 billion) at Wednesday's long-term refinancing operation (LTRO), with forecasts ranging from 200 billion to 750 billion euros.

It (LTRO) is a very strong blanket under the market and creates a safer environment for the financing of banks. It has also helped in lowering volatility, said Didier Duret, global chief investment officer of ABN AMRO Private Banking, which manages about 170 billion euros.

A better-than-expected allocation would prompt speculators to buy more equities and help the market gain further ground, Didier said, adding the bull run was not over and equities could gain a minimum of 5 percent in three to six months.

At 1233 GMT, the STOXX Europe 600 index was up 0.2 percent at 264.35 points, while the FTSEurofirst 300 index of top European shares rose 0.2 percent to 1,075.86 points.

The FTSEurofirst index, which fell 10.7 percent in 2011, hit a seven-month high last week and is up 7 percent this year.

There is every reason to believe the European market could make up for lost ground in the years ahead, and offers substantial upside potential. Our cautious scenario gives us a STOXX 600 objective of 285 points, said Jacques Chahine, chairman of J. Chahine Capital that manages about $400 million.

Charts also pointed to more gains. The euro zone's blue-chip Euro STOXX 50 index, up 0.4 percent at 2,524.06 points, was at the verge of a bullish technical signal known as a golden cross, with its 50-day moving average was about to break above its 200-day average.

The golden cross is used as a 'buy' trigger by a lot of automatic trading programmes, a Paris-based trader said.

ASSET ALLOCATION

Didier said ABN AMRO Private Banking this month changed its portfolio to neutral on European equities from underweight by reducing its cash holdings to 20 percent of its portfolio from 28 percent at the start of the year.

In Europe, ABN AMRO bought shares of companies in industrials and consumer discretionary sectors in January and February, he said.

Deutsche Bank's fund flows data showed U.S. investors were more upbeat on European equities than Europeans themselves.

Funds domiciled in Europe have seen outflows from western European equity of 0.8 percent year to date, while U.S.-domiciled funds (invested in European equities) have received inflows of 7.1 percent.

Cyclical shares were in demand on Tuesday, with the STOXX Europe 600 automobile index rising 0.8 percent, helped by a 5.7 percent rise in PSA Peugeot Citroen after sources said General Motors was in advanced talks to buy a small stake in the French automaker.

STMicroelectronics rose 5.4 percent after the group's mobile joint venture with Ericsson, ST-Ericsson, won a contract from handset maker Samsung .

Mining shares rose 0.5 percent, tracking a rise in key base metals prices on expectations of an improvement in demand for raw materials.

However, gains in equities were limited as credit agency Standard & Poor's downgraded Greece's long-term rating to selective default, and Chancellor Angela Merkel's room for manoeuvre on future euro zone bailouts shrank further when Germany's top court raised a hurdle to swift action in financial rescues.