European stocks rallied on Wednesday afternoon, as banking stocks bounced on revived hopes euro zone leaders will take major steps at a summit this weekend to tackle the region's debt troubles.

Gains were limited as benchmark indexes neared major resistance levels again, after failing to convincingly break above them on four occasions over the past week.

The FTSEurofirst 300 .FTEU3 index of top European shares was up 1 percent at 972.11 points at 1118 GMT, rising toward the 50 percent retracement of its slump from late July to late September.

Valerie Gastaldy, head of technical analysis firm Day By Day, said: The signals from different markets all point toward consolidation. Better to wait before taking new positions.

Euro zone banks led the gains, with BNP Paribas up 4.6 percent and Deutsche Bank up 5.4 percent.

Investor sentiment was boosted by a report in Britain's Guardian newspaper a deal had been reached by France and Germany to scale up the European Financial Stability Facility to more than 2 trillion euros, a story later denied by two senior European Union officials.

Tech shares bucked the trend, with Alcatel-Lucent down 4.3 percent and Ericsson down 3.6 percent following gloomy comments from U.S. peers Juniper Networks and Powerwave Technologies.

Apple's lower-than-expected results also weighed on the sector, and sending its own shares traded in Frankfurt down 5.4 percent.

Around Europe, Britain's FTSE 100 index .FTSE was up 1.5 percent, Germany's DAX index .GDAXI up 1.5 percent, and France's CAC 40 .FCHI 1.2 percent higher.

RISING SHORT INTEREST ON GERMAN STOCKS

Following economic data that beat forecasts, short interest in U.S. stocks has dropped recently, Societe Generale strategists said. Better-than-expected economic data in the U.S. and hope of a decisive easing of the eurozone's troubles prompted hedge funds to cut their shorts sharply against equity in recent weeks, although they are far from being eliminated.

The picture was different for German stocks, with data showing the average short interest across all German equities rising to 1.8 percent of total shares, well above the European average of 1.2 percent, according to Data Explorers.

Figures from the London-based research firm which tracks short interest showed the biggest short interest on German stocks was in the information technology, solar and industrial sectors.

Short selling was the best-performing hedge fund strategy in September, posting a performance of 8.1 percent, according to EDHEC-Risk Institute data. It remains the best performing strategy in 2011, with a return of 13.4 percent.

VALUATION RATIOS ON THE RISE

Europe's broad STOXX 600 has gained 14 percent since hitting a floor in late September which, combined with recent downward revisions in analyst forecasts, has pushed the average 12-month forward price-to-earnings ratio to a 2-1/2 month high of 9.16, data from Thomson Reuters Datastream showed.

The ratio of put/call open interest on Euro STOXX 50 .STOXX50E has also risen, signaling improvement in investor sentiment. The ratio hit a five-week high of 1.1603.