LONDON European shares built on their best day in seven months and the euro dropped to a three-week low on Wednesday after weak data bolstered expectations for a European Central Bank rate cut.
Europe's stock markets have rallied as poor data from the euro zone has raised hopes the ECB will cut the main interest rate next week to a new record low of 0.5 percent and consider more radical measures such as targeted lending aid for firms.
There was fresh gloom on Wednesday as German business morale fell for the second consecutive month, missing even the lowest estimate in a Reuters poll and signalling that Europe's largest economy is struggling to shrug off its recent slowdown.
A quarterly survey of bank lending by the ECB also painted a bleak picture as it showed demand for loans from firms and consumers plummeted in the first three months of the year and was expected to deteriorate further this quarter.
"In the short run, worsening prospects for the German economy could at least increase the silent support for more ECB action," said ING economist Carsten Brzeski.
"A rate cut and more non-standard measures will not kick-start economies but weaken the euro exchange rate. Particularly a weaker euro could be a welcome relief for exporters."
Top European shares on the FTSEurofirst 300 climbed 0.3 percent to add to Tuesday's jump of almost 2.5 percent and pushed back towards last month's 4-1/2 year high.
London's FTSE 100, Paris's CAC-40 and Frankfurt's DAX were up 0.3, 0.7 and 0.5 percent respectively, while in the currency market the euro came under fresh selling pressure.
It was already on the back foot after Tuesday's weak German PMI data and the latest disappointing figures pushed it to a three-week low of $1.2954. At the same time, the dollar hit a three-week high against a basket of currencies.
"Everyone is now really betting on the ECB to come to the stage and cut the key rate," said Carolin Hecht, currency strategist at Commerzbank.
"Already the PMI yesterday had given an impulse to the downside (to sell the euro) but some were waiting for the Ifo to confirm the economy is not really recovering."
Rate cut expectations have also pushed Italian and Spanish bond yields to their lowest levels in 2-1/2 years in recent sessions as investors have started to look for higher returns..
Italy's expected nomination of a new prime minister after months of uncertainty has also helped support risk assets.
Italian President Giorgio Napolitano will name the new premier later. He has called the deputy head of the centre-left Democratic Party Enrico Letta to his palace, indicating he was likely to be asked to form a new coalition government.
Underscoring the ferocious appetite for yield, Rome had to pay the lowest rate on a 2-year, zero coupon bond since 1999 at its latest debt sale, while yields at a 1.68 billion euro sale of German 30-year debt hit an all-time low of 2.16 percent.
"Clearly the outlook that (ECB)rates will stay low for a long, long time is increasing demand for anything that still has a yield," said Berenberg bank economist Christian Schultz
"But you would not buy Italian bonds unless you felt there had been a change in the risk perception. Ever since the ECB provided its safety net there does seem to be a growing confidence in the market that we won't see a euro break up."
The slowdown in manufacturing activity around the world shown in this week's data kept the pressure on commodity markets although hopes for further central bank liquidity ensured there was little selling pressure.
U.S. investment bank Goldman Sachs raised its rating on equities as a global asset class to "overweight" from "neutral" over the coming 3 months, while cutting its position on commodities to "neutral" from "overweight".
Three-month copper on the London Metal Exchange rose by around 1.75 percent to be just under the $7,000 a tonne having fallen to an 18-month trough of $6,762.25 on Tuesday.
Brent crude rose 0.7 percent to climb back above $101 a barrel gaining added support from fears that OPEC could cut oil supply if prices fall more.
The Organization of the Petroleum Exporting Countries, which pumps more than a third of the world's oil, is scheduled to meet on scheduled on May 31 but oil hawks Venezuela and Iran have called for an emergency meeting to consider output cuts.
Gold continued its recent recovery from last week's big falls as it climbed around 1 percent to $1,425 an ounce.
"Good physical demand in China or in Hong Kong supports gold, but sentiment is still bearish," said Peter Fung, head of dealing at Wing Fung Precious Metals in Hong Kong.
(Additional reporting by Marius Zaharia; editing by Anna Willard)