European shares steadied on Tuesday in low volume as last week's tentative rally petered out, with Italian banking stocks hit after the country's bond yields rose on worries that thin liquidity would weigh on an Italian sovereign debt auction on Thursday.

Volume was less than a quarter of its 90-day daily average, distorting movements in Europe, with the UK market shut for a bank holiday.

Italian banks were the worst performers in Europe after 10-year Italian bond yields rose to a level deemed unsustainable as concerns grew that thin liquidity could make it difficult for Rome to raise up to 8.5 billion euros at Thursday's debt auction.

Italy's UniCredit and Intesa Sanpaolo , whose performance are highly correlated to the country's bond yields, were the standout decliners, down 4.8 and 2.4 percent, respectively.

Italian bond yields are rising, liquidity is light and it is very difficult to predict what could potentially happen at Italy's bond auction later in the week, a London-based trader said.

There has not been a concrete resolution to the problems in euro zone debt. Italy is engulfed in the crisis, and until borrowing costs come down equity markets will be hit, the trader said.

The Italian market was the worst-performing exchange, down 1 percent, while the pan-European FTSEurofirst 300 <.FTEU3> index of top shares closed up 0.04 percent at 990.35 points after gaining 3.4 percent in the previous week helped by positive U.S. data.

Although stocks edged higher after U.S. consumer confidence rose more than expected in December, not all economic figures were good. Weak U.S. housing data raised doubts that the housing market is on the path to recovery.

PORTUGAL GAINS

On the flipside, Portugal's PSI 20 <.PSI20> rose 1.1 percent and was one of the best-performing exchanges, helped by banking stocks on hopes Chinese lenders will take stakes in the country's banking sector.

Banco Espirito Santo , Millennium Bcp and Banco BPI were among the best performers in Portugal, rising between 7.7 percent to 13.9 percent.

There is the prospect of Chinese capital entering the Portuguese banking sector as a whole. Banking stocks are worth peanuts and there have been some sales in the past week in the market, said Jose Lagarto, a broker at Orey iTrade.

(Reporting by Joanne Frearson; Editing by Leslie Adler)