European shares up on euro zone progress

LONDON (Reuters) - The euro hit a six-month high and European shares and peripheral euro zone bonds added to recent gains Tuesday, as optimism over Greece's plan to buy back debt and signs of progress elsewhere in the bloc boosted sentiment.

The FTSEurofirst 300 index of top European shares was up 0.3 percent at 1124.97 points at 1045 GMT, with London's FTSE 100, Frankfurt's DAX and Paris's CAC-40 all in positive territory after a mixed open.

A surprise drop in U.S. manufacturing data and signs of difficulties in U.S. budget talks had hit Asian and U.S. stocks, but Europe was brighter, leaving world shares up 0.1 percent.

News that Greece, which first triggered the euro zone crisis three years ago, was planning to buy back bonds to cut its debt, reassured investors across asset classes.

The buyback is a crucial part of a deal reached last week by Greece's international lenders to cut its debt pile and needs to be completed before the IMF can release its share of the aid.

"Greece is on track with its debt buy back, Spain came out and said it would take the 40 billion for its banks, and Portugal will get its next round of funding," said Heinz-Gerd Sonnenschein, equities strategist at Postbank in Germany.

"Market participants were really encouraged by the Greek buy back, so with it looking like Europe is on track, it is now over to the U.S. (to find a fiscal cliff deal)."

Global shares have risen 5 percent over the last two weeks as euro zone progress and signs of growth picking up in key economies like China have offset fears the United States could go into recession if political talks on tax hikes and spending cuts fail.

Worries loomed large on Monday after the White House dismissed a budget proposal from Republicans, saying it did not meet President Barack Obama's pledge to raise taxes on the rich.

With little in the way of data to take investors' minds off the budget wrangling, U.S. stock futures pointed to a steady open on Wall Street when trading resumes later.

EURO HIGH

In currency markets, the euro extended its recent rally, hitting a fresh six-week high of $1.3077 against the dollar and 1.2116 francs against the Swiss franc.

"Overall the euro zone noises are coming out positive, and I don't see any turning around there. The only real deal-breaker, (which) will send the dollar spiking up and risk really off the table, will be if there is a complete breakdown in the Congress negotiations," said Vishnu Varathan, regional economist in Singapore for Mizuho Corporate Bank.

"Right now there is some disappointment here and there, but overall still the consensus is that negotiations will result in some kind of acceptable compromise."

The European single currency's rise helped push the dollar to a one-month low against a basket of currencies, with its index .DXY falling to 79.742.

Elsewhere, the Australian dollar recovered from initial weakness after a widely expected interest rate cut by the Reserve Bank of Australia (RBA). The rate was trimmed by 25 basis points to 3.0 percent, matching the previous record low.

Commodities struggled, as weak manufacturing data and protracted U.S. budget negotiations fanned concerns about the health of the global economy and the prospects for energy demand.

Oil and gold both lost ground, while copper was little changed. Brent crude oil dipped to $110.60 a barrel, and gold fell about 1 percent to its lowest in nearly a month after prices broke below key support levels.

PERIPHERAL VISION

With the euro zone mood lifting, Spanish, Italian and Greek bonds led a renewed rise in demand for higher-yielding euro zone bonds. It kept German Bunds on the back foot, though losses were limited by the potential impasse in budget talks.

Italian 10-year yields fell 5 basis points to 4.40 percent, while the Spanish equivalent was 3 ticks down at 5.24 percent, extending Monday's falls after Greece unveiled better-than-expected terms for its debt buyback.

The terms improved the chances of its success, prompting investors to keep piling into lower-rated euro zone bonds and driving the Italian 10-year yield premiums over Bunds below 300 basis points for the first time since March.

"We think that the big items such as an imminent bankruptcy in Greece is off the table. The overall climate is in favour of investors looking for yield everywhere, and so the way of least resistance is for a narrowing of yield spreads," said Piet Lammens, a strategist at KBC.

(Additional reporting by Emelia Sithole-Matarise; Editing by Will Waterman)