LONDON World shares hit a new 20-month high on Tuesday after Japan launched it boldest attempt yet to lift its stagnant economy, though the gains were cropped by a flare-up of concerns about Germany's banks.
The Bank of Japan, which has been under intense political pressure to overcome deflation and generate growth, hiked its inflation target to 2 percent and said that from 2014 it would adopt an open-ended commitment to buy assets to ease monetary conditions.
The move surprised markets, which had expected another incremental increase in its 101 trillion yen asset-buying and lending programme, though the delay before the easing measures kick in dulled the impact and saw the yen edge higher against the dollar.
European shares, which have been testing two-year highs in recent days, experienced a turbulent morning as markets latched on to a report that German regulators were simulating a separation of some banks' operations, and on rumours - later denied - that Deutsche Bank (DBKGn.DE) was preparing a profit warning.
Frankfurt's DAX fell as much as 1.4 percent but had clawed back half of the losses by 1100 GMT. London's FTSE 100, Paris's CAC-40 and Madrid's IBEX were between flat and down 0.3 percent, leaving the FTSEurofirst 300 down 0.2 percent on the day.
A better-than-expected reading from the German ZEW investor sentiment index helped the recovery. It rose sharply for a second consecutive month in January in a sign that the euro zone crisis is no longer hitting Europe's largest economy as hard as in late 2012.
"A slight improvement was expected, but the actual recovery was significantly better," said Stefan Kipar, an economist at Bayern LB.
"All in all, the indicators are showing that financial analysts increasingly expect a recovery of the German economy in the spring."
Equity markets, particularly in Japan, had risen strongly in the run-up to Tuesday's BOJ meeting, and the confirmation of the central bank's plans was enough to lift the MSCI world index 0.15 percent to a fresh 20-month high of 352.54.
Brent crude rose 0.3 percent to $112.07 a barrel, and gold was up 0.2 percent as the BOJ's easing action added to recent positive data from the United States and China, while growing confidence in the strength of China's economic recovery pushed copper up 0.7 percent to $8,120 a tonne.
General market sentiment was also supported by signs of a compromise to avert a U.S. fiscal crisis.
Republican leaders in the U.S. House of Representatives have scheduled a vote on Wednesday on a nearly four-month extension of U.S. borrowing capacity, aimed at avoiding a fight over the looming need to raise the federal debt ceiling.
Bond market investors were also eyeing a new 10-year Spanish bond sale, its first since November 2011, as the latest evidence of its rising confidence following the European Central Bank's promise to buy its bonds if necessary.
Last week, Rome sold 6 billion euros of its first 15-year bond in more than two years.
"Anything below 4 billion (euros) would most likely be seen as a disappointment after the Italian deal," Michael Leister, senior interest rate strategist at Commerzbank, said of Spain's sale.
The upbeat German ZEW release, which put German investor and analyst morale at a 2-1/2 year high, prompted a fall in German government bonds and lifted the euro.
The single currency was down 1 percent on the day against the yen at 118.3 yen, however, as disappointment that there will be no immediate BOJ easing saw the yen strengthen across the board.
The dollar also fell 1 percent against the yen to a session low of 88.365 yen.
"There was some disappointment in markets that the BOJ would start their open-ended bond purchases only in January 2014, so we see some profit taking in dollar/yen," said Bernd Berg, global FX strategist at Credit Suisse.
(Additional reporting by Anooja Debnath; Editing by Will Waterman)