* Greek bank shares jump more than 4 pct, lead stocks higher
* Bond yield spread tightens by 24 bps, seen narrowing more
* Papandreou rules out early national election
By George Georgiopoulos
ATHENS, Nov 8 (Reuters) - Financial markets greeted Greek Prime Minister George Papandreou's decision not to call early national elections with relief on Monday with bond yield spreads narrowing and shares rallying, led by banks.
Papandreou's threat of snap polls if his ruling socialists fared poorly in Sunday's municipal polls had unnerved markets, pressuring equities and contributing to more than 200 basis points of spread widening as investors braced for political risk in a bad week generally for peripheral euro zone countries.
"Banks are showing strength, leading the broader equities market higher. Traders are relieved the worst-case scenario of early national elections is out of the picture, reducing uncertainty," said Theodore Krintas, head of wealth management at Attica Bank.
At 0919 GMT, The Athens stock exchange's banking index was up 3.05 points, trimming earlier gains of more than 4 percent, still leading the broader market's 2.1 percent advance.
Greek banks, down 45 percent year-to-date, are fortifying their balance sheets through cash calls and asset sales to reduce dependence on European Central Bank funding and cushion the impact of recession and the debt crisis.
The country's largest lender National Bank, which raised 1.8 billion euros last month via a rights issue was gaining 3.8 percent to 7.67 euros. Alpha Bank climbed 4.6 percent.
JITTERS EASE
Barely a year in office, Papandreou had threatened to dissolve parliament if the first round of regional polls failed to give him a mandate to pursue budget cuts and reforms agreed in May under a 110 billion-euro ($154.4 billion) EU/IMF bailout to save Greece from bankruptcy.
Making things worse, he toyed with voters' and markets' nerves by not being clear about what would constitute a big enough disapproval of his policies to prompt snap polls.
Papandreou late on Sunday ruled out a dissolution of parliament. With 96 percent of the vote counted on Monday, his socialist party (PASOK) was ahead in seven out of 13 regions in the first round. In the 2009 national elections, PASOK won in all 13 regions.
In the bond market, the yield spread of 10-year Greek government paper over German bunds tightened by 24 basis points to 900 bps, starting to retrace part of its big move from around 650 bps, when Papandreou first hinted of snap polls.
"We are seeing a positive reaction, as a chunk of risk is removed, other things being equal, leading to tighter spreads," said economist Platon Monokroussos at EFG Eurobank. "We may see further narrowing to 800 bps this week."
One clear message in Sunday's polls was that voters did not want early elections. Based on one exit opinion poll, more than 76 percent had a negative view of Papandreou's tactic to threaten snap polls and three out of 10 said it did affect the way they voted.
Many showed their discontent with abstention. About 40 percent of voters did not show up at the polling stations and some 10 percent of those who did cast a blank or invalid ballot.
Traders said despite the relief rally Greece was not out of the woods yet and challenges remained as it struggles to dig out of its debt crisis.
"The positive reaction after the significant deterioration in sentiment was to be expected with the threat of snap polls removed. But the relief rally has an expiration date, there is an upcoming revision of last year's deficit by Eurostat in mid-November and the finalisation of next year's budget," said a trader at an Athens-based securities firm who declined to be named. (Editing by Stephen Nisbet)