European stocks rose on Monday, as a renewed pledge by France and Germany to come up with a plan by the end of the month to tackle the euro zone debt crisis and support the region's banks helped the market extend its sharp rally into a fourth session.

However, mounting expectation of a wave of recapitalisation in the banking sector as well as Erste Group Bank's warning that it would make a big loss this year prompted investors to book a portion of the recent strong gains made on banking stocks.

At 1116 GMT, the FTSEurofirst 300 index of top European shares was up 0.8 percent at 954.97 points. The benchmark index has gained nearly 9 percent since reaching a low last Tuesday.

The index's next resistance levels are at 978.57 points, which represents a high reached on Sept. 1, and 983.41 points, the 50 percent retracement of the July 22-Sept. 23 nosedive.

We're getting signals on a lot of fronts that the end of the crisis is coming. The rally in Bunds is exhausted, shaping up a triple-top pattern on the chart, and we're getting a 'sell' signal on the volatility, said Valerie Gastaldy, head of Paris-based technical analysis firm Day By Day.

Bund futures fell below 135 and hit their lowest level since early September on Monday, after failing to convincingly break above 139 in three occasions over the past month, signalling a potential change in trend.

European stocks and Bunds tend to move in opposite directions, with the 25-day rolling correlation between the broad STOXX 600 index and Bunds futures at -0.78 on Monday.

VOLATILITY RECEDES

The Euro STOXX 50 volatility index , Europe's main fear gauge known as the VSTOXX index, dropped to its lowest level since early September and broke out of an ascending triangle chart pattern, invalidating the figure that had been pointing towards a sharp rise in volatility.

The index, which measures the cost of protecting against a decline in shares on the Euro STOXX 50 index , was down 3.3 percent at 39.23, moving below the key level of 40.

The bottom line for European equities is that banking stocks have recently shown resilience despite that nothing has really changed on the news front, Gastaldy said.

The question now is: is this the start of a bear market rally that will last for a few weeks, or is it the start of a trend that could go on for six months? It too early to say.

Shares of Erste Group Bank tumbled 14 percent after the East European lender warned it would post a big loss on the year and will not pay a dividend after taking hits on its foreign currency loans in Hungary and euro zone sovereign debt.

Societe Generale was down 0.4 percent, HSBC down 0.2 percent and UBS down 0.3 percent, as investors booked recent lofty gains. Europe's STOXX banking index has surged 17 percent since hitting a low in late September.

Over the weekend, German Chancellor Angela Merkel and French President Nicolas Sarkozy said they would work out a plan to recapitalise European banks, come up with a sustainable answer to Greece and accelerate economic coordination in the euro zone by a G20 summit in Cannes on Nov. 3-4.

Recapitalising the banks would be a strong signal sent to the market, even if banks don't necessarily need fresh funds, KBL Richelieu analyst Benoit de Broissia said.

It would help ease the tensions and restore investors' confidence in the sector. The best solution would certainly be an investment from states in the form of preferred shares that could be bought back when things settle down.