European stocks rose on Monday, with the blue chip Euro STOXX 50 index hitting a three-month high, as investors bet the European Central Bank will unveil steps to ease Spain and Italy's soaring borrowing costs at its meeting later this week.
But the benchmark index, which has soared nearly 8 percent in three days in brisk volumes, was halted by a major resistance level representing the 50 percent retracement of the March-June slump, and traders and fund managers said stocks looked ripe for a bout of profit taking after such a bounce.
At 1106 GMT, the FTSEurofirst 300 index of top European shares was up 1 percent at 1,067.07 points, a level last seen in early April.
The Euro STOXX 50 index was up 1 percent at 2,324.03 points, after briefly rising to a three-month high of 2,335.15.
The blue-chip index has managed to move above its 200-day moving average, at 2,323, but was capped by another major resistance level at 2,331, the 50 percent retracement of the March-to-June slide.
"The market's recovery has been extremely quick, and we're cautious on the short term," Agilis Gestion fund manager Arnaud Scarpaci said.
"But beyond that, the medium-term picture is changing and there's no doubt left in investors' minds about the ECB's ability to act decisively to change the game. There's still a high level of pessimism priced in, so the risks seem to be on the upside," he said.
Euro zone banking stocks featured among the top gainers, with Bankia up 6 percent, Banco Popolare up 5.3 percent and Credit Agricole up 5.6 percent.
Recent comments by European officials including ECB chief Mario Draghi have sparked expectation that the bank would take steps to lower the cost of borrowing of Spain and Italy when it meets on Thursday, triggering a sharp recovery rally in equities over the past few sessions.
Shares extended their gains in mid-morning on Monday after Italy's 10-year funding costs fell below 6 percent for the first time since April at an auction, as hopes of new measures to ease the debt crisis fuelled demand for the country's debt.
However, a number of investors doubted that ECB policymakers would deliver in line with market expectations this week, given Germany's Bundesbank still opposes a resumption of the bond-buying programme, seen as crucial to capping Spanish and Italian borrowing costs.
"Markets have reached a point that has priced in action by the ECB. This sets up a situation where Draghi will now have to back his words with action or we could see markets tumble quicker than they rallied," GFT market strategist Andrew Taylor warned.
Also capping gains on Monday, data showed Spain sinking deeper into recession in the second quarter, and economic sentiment in the euro zone fell again in July as the bloc's economy deepened its slump and factory managers and businesses became more pessimistic.
RISK APPETITE RECOVERING
But despite the grim macro picture, Europe's equity derivatives market was sending signals of a strong recovery in investors' appetite for risk, with the put/call ratio on the Euro STOXX 50 falling to a one-month low of 0.57, according to data from the Eurex exchange.
A ratio of 1 or below usually signals bullishness.
Signs of a shift in investors' mood was also emerging from last week's fund flow data from EPFR Global.
Data showed Europe equity funds recorded overall outflows for the third straight week, with retail redemptions on the rise, but institutional investors committed money to these funds for the fifth time in the past six weeks, data showed.
Around Europe, UK's FTSE 100 index was up 0.5 percent, Germany's DAX index up 0.8 percent, France's CAC 40 up 0.5 percent, Spain's IBEX up 1.8 percent and Italy's FTSE MIB up 2.1 percent.
On the earnings front, Air France-KLM jumped 14 percent after saying it has halved its operating loss on improved passenger activity, while JCDecaux tumbled 11 percent after saying demand for its outdoor advertising slowed in the second quarter in recession-hit Europe, which accounts for the bulk of the French company's sales.
According to Thomson Reuters StarMine data, about 40 percent of European companies on the STOXX Europe 600 index have reported results so far in the current earnings season, of which 53 percent have beaten or met expectations.