(REUTERS) - European stocks rose early on Monday, adding to last week's 8.5 percent jump on growing hopes of a comprehensive solution to the Eurozone debt crisis as French President Nicolas Sarkozy and German Chancellor Angela Merkel meet ahead of a key summit.
Italy's fresh 30 billion euro package of austerity measures also eased tensions surrounding the country's finances and sparked a rally in Italian shares, with Milan's FTSE MIB index up 3.1 percent while Italian 10-year bond yields dropped towards 6 percent.
Banco Popolare surged 7 percent, UniCredit rose 5 percent and Enel was up 3.6 percent.
At 1230 GMT, the FTSEurofirst 300 index of top European shares was up 1 percent at 994.84 points, a level not seen in five weeks.
Markets now seem to want to believe that Merkel and Sarkozy will come out with a common point of view and a lot of austerity and structural measures to bring down the debt and increase competitiveness, said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels.
And when you listen at their speeches, it looks like the points of view which were far apart clearly have come closer together. If they manage to come to an understanding, they still have to sell some of these very unpopular measures to the rest of Europe. And this would open the door for the European Central Bank to get more involved.
Shares in financial institutions led the gains, with ING Groep up 3 percent, BNP Paribas climbing 5.5 percent and BBVA up 2.6 percent.
The STOXX euro zone banking index .SX7E has surged 23 percent since tumbling to a near-three year low in late November.
Commerzbank (CBKG.DE) bucked the trend, sinking 7 percent after announcing the buyback of 600 million euros of hybrid capital instruments in an bid to meet European capital requirements without asking for more state intervention, but the move was seen as too timid by investors.
The euro zone's blue chip Euro STOXX 50 index was up 1.5 percent at 2,377.67 points, partly filling a downward gap on the chart left open in early November.
The benchmark index was reaching 'overbought' territory, with its 9-day relative strength index (RSI) at 68.5, signaling the index was poised for a short-term pull-back. A reading of 70 and above is considered 'overbought.'
Despite Monday's gains on the market, The Euro STOXX 50 volatility index -- Europe's yardstick of investor sentiment known as the VSTOXX -- was steady at 35.7, signaling investors' hesitation about piling up more risky assets before the outcome of the Merkel-Sarkozy meeting.
RIPE FOR PULL-BACK?
Kepler Capital Markets trader Patrice Perois said the market looked ripe for a pull-back after its best weekly gain in three years.
There are still significant differences between Sarkozy and Merkel, so we're in for a volatile week, and the risk is that any kind of disappointment could trigger a pull-back, he said.
But the medium term looks relatively positive. The Italian government is really regaining credibility, and that's very important to restore confidence.
Meeting in Paris on Monday ahead of a key European Union summit later in the week, Sarkozy and Merkel are under pressure to iron out their differences on how to centralize control of Eurozone budgets to resolve the region's debt crisis.
The two leaders, who are due to meet at 1230 GMT on Monday and are expected to hold a news conference afterwards, will try to reach common ground on measures to boost coercive budget discipline in the Eurozone, likely via EU treaty change, which they want all 27 EU leaders to approve at Friday's summit.
Too many times before, Eurozone leaders have pledged their determination to end the crisis, but end up merely fudging the issue and delaying any decision until later, said IG Markets analyst Chris Beauchamp.
The fear now is that this week will turn out the same way, with fine words but little action.
Around Europe, UK's FTSE 100 index was up 0.7 percent, Germany's DAX index up 0.9 percent, and France's CAC 40 up 1.4 percent.
Investors shunned defensive shares on Monday such as big pharmaceutical groups, with Novartis down 0.2 percent and AstraZeneca down 0.3 percent.
German business software maker SAP (SAPG.DE) fell 2.5 percent after launching a $3.4 billion takeover offer for SuccessFactors, seen as an expensive price tag for the U.S. software company.
The acquisition is way too expensive. Even if you take into account 2013 yields, the price-to-profit ratio is 165, said analyst Heino Ruland at Ruland Research. This reminds me of the internet bubble of more than a decade ago.
Looking forward, JP Morgan strategists see opportunities in derated cyclical stocks and geographically prefers exposure to core Europe, in particular Germany's DAX, over peripheral countries while the near-term outlook remains challenging.
We believe selected cyclicals have been penalized too much, especially the emerging market sensitive ones. We find value in 'low ROE' (return on equity) and 'Value' styles, they wrote in a note.