* FTSEurofirst 300 ends up 0.4 pct, Euro STOXX 50 up 1 pct
* Speculation ECB will intervene to tackle crisis boosts EZ banks
* Italy's FTSE MIB up 2.4 pct as sovereign bond yields falls
By Francesco Canepa
LONDON, Aug 21 (Reuters) - European shares rose in thin trade on Tuesday, boosted by renewed speculation the European Central Bank would act to rein in the sovereign debt crisis in the euro zone.
Euro zone banks soared 2.7 percent and yields on benchmark Italian and Spanish bonds fell further as investors continued to speculate the ECB would intervene in the debt market to reduce borrowing costs for struggling countries.
The falling bond yields helped Italy's FTSE MIB to climb 2.4 percent and outperform all other western European national indexes, led by heavyweight financials including Intesa Sanpaolo, big holders of the country's debt.
"There are many uncertainties but, still, the ECB is going to take a more active role concerning the debt crisis in Europe," said Matthias Thiel, a capital markets strategist at M.M Warburg & CO in Hamburg.
"With the action of the ECB, (a euro zone break-up) is getting more unlikely. That means there is some potential that equity markets, in southern Europe especially, are going to rally further."
Warburg, which has assets worth 38 billion euros under management, increased the weight of European equities and bonds in its portfolio to "benchmark" from "underweight" last month and beefed up its positions after ECB Chairman Mario Draghi said he was prepared to do "whatever it takes" to save the euro.
Thiel cautioned he would need to see what course of course of action the ECB would take and data showing the global economy is bottoming out before adopting a positive stance on European equities.
Traders highlighted an article in London's Daily Telegraph that the ECB was examining plans to put a hard cap on Spanish and Italian bond yields, even though an initial report in German weekly Der Spiegel on the potential bond-buying strategy was played down by bank officials on Monday.
The FTSEurofirst 300 rose 0.4 percent to 1,109.55, having traded 62 percent of its 90-day volume average.
The Euro STOXX 50 index rose 1 percent to 2,490.27 points and was up around 15 percent since Draghi's comments on July 26.
The euro zone blue-chip index climbed further into "overbought" territory on its 7-day wilder smoothing relative strength index charts, Thomson Reuters data showed
The indicator rose to 76.9 from 71.9 on Tuesday, where a reading of 70 or more indicates "overbought" conditions.
"On a short-term basis Europe remains overbought and we continue to expect a setback/correction into later September and into October," Michael Riesner, head of equity technical analysis at UBS, said in a note.
"However, given the recent strong momentum it is very likely that we will see a higher low in the major headline indices, which then should serve as the next tactical buying opportunity in early Q4."
Market optimism was set to be put to the test in the coming weeks, with the European Central Bank's next policy meeting scheduled for Sept. 6, followed by a ruling by Germany's constitutional court on the European Stability Mechanism on Sept. 12.
Dermot Corrigan, a partner at London-based trading firm Qubed Derivatives, said he was sceptical the ECB could get Germany's stamp of approval to set a cap on bond yields, an operation that he said "would require an open-ended commitment" to buy sovereign bonds.
"Didn't George Soros break the Bank of England back in 1992 when they were trying to defend the pound within the ERM (European Exchange Rate Mechanism)?," Corrigan said.
"Obviously the numbers today are a lot bigger and there's much more at stake but anything Draghi wants to do will have to have German approval."
Investors will also keep a close eye on Greek Prime Minister Antonis Samaras's meetings with German Chancellor Angela Merkel, French President Francois Hollande and Eurogroup chief Jean-Claude Juncker later this week as he tries to secure more funding from the EU, International Monetary Fund and ECB, despite Greece falling behind on its debt cut targets.
Derivative markets showed some investors were starting to use options to lock in recent gains.
The Euro STOXX 50 implied volatility index, which gauges option prices on the euro zone blue chips index and is regarded as a yardstick of investor 'fears' of future share price swings, bounced from one-month lows to close up 0.2 percent on Tuesday.
The 10-day moving average of the put/call ratio on the Euro STOXX 50 remained above 1.1, meaning more options to sell the index at a future date than to buy it were traded, Thomson Reuters Datastream data showed.
"Put-call ratios (are) back to more normal levels (of more than 1) - reflecting increased protection interest," UBS Equity Derivatives Global Experience said in a note.
"In Europe we saw a pick-up in activity into the end of last week and the Aug. 12 expiry, followed by a quieter session yesterday."