* FTSEurofirst 300 closes 1.1 pct higher
* Banks lead gainers; Italy's Intesa SanPaolo, UniCredit soar
* Ericsson slunps after profit misses forecast
By Brian Gorman
LONDON, July 21 (Reuters) - European shares closed at their highest in nearly two weeks on Thursday on investor optimism about a plan for a wide-ranging response to the euro zone sovereign debt crisis.
Banks were the standout gainers, extending a rally into a third day and lifting the STOXX Europe 600 Banking Index 4.1 percent, led by heavyweights including Intesa SanPaolo and UniCredit , up 9.5 and 10.4 percent respectively.
The Greek bank sector rose 7.7 percent and the Thomson Reuters Peripheral Eurozone Banking Index was up 7.7 percent.
Other banks to gain included Banco Santander , Credit Suisse and Societe Generale , up between 4.4 and 6.2 percent.
The European banking sector was further helped by strong results at U.S. peer Morgan Stanley , whose stock rose more than 10 percent.
Euro zone leaders were set to give their financial rescue fund sweeping new powers to prevent contagion and help Greece overcome its debt crisis, according to the draft conclusions of an emergency summit.
The leaders met in Brussels after the European Central Bank signalled in a policy reversal it was willing to let Greece default temporarily under a crisis response that would involve a bond buyback, a debt swap but no new tax on banks.
The FTSEurofirst 300 index of leading European shares rose 1.1 percent to 1,103.12 points, its highest close since July 8 and its third straight day of gains.
"It seems that everything they could have put in the mix, they have done," said Bernard McAlinden, strategist for the European Securities Network. "This can buy some time for economies to put their house in order."
The pan-European index is up 3.5 percent from the 2011 low it hit on Tuesday, but is still down more than 7 percent from the 2011 high of 1,190.51 it hit in mid-February.
The euro's strong correlation with stocks, which often makes it a gauge of "risk-on/risk-off" trade, was near a record high. The 66-day rolling correlation between the euro and the Euro STOXX 50 index has risen to 0.921.
The euro was up 1 percent against the dollar, while the Euro STOXX 50, the euro zone's blue-chip index, was up 2.2 percent. Both reversed losses from earlier in the session.
The Euro STOXX Volatility index plunged 13.6 percent, reflecting the reassurance the proposals had given some investors.
THROWING MONEY
However, some traders were sceptical about how effective the proposals would be. "It's just the same old nonsense rehashed in a slightly different packaging. It's throwing more money at Greece," Michael Hewson, market analyst at CMC Markets, said.
"You can talk about extending the EFSF loans. It doesn't deal with the underlying issue. Greece is technically insolvent. Once you drill down into the detail, does it really solve the underlying issue? On the face of it, no."
The weaker dollar did not prevent copper falling as data showed shrinking manufacturing activity in top consumer China, fuelling demand fears. The STOXX Europe 600 Basic Resources Index fell 0.4 percent.
The latest batch of second-quarter European earnings was
mixed. Ericsson
Across Europe, Britain's FTSE 100 rose 0.8 percent; Germany's DAX and France's CAC40 rose 1 and 1.7 percent respectively.
"There have been many false dawns when it comes to drawing a line under the European debt crisis, so it might be a little ambitious to expect this current enthusiasm to continue into Friday when traders have had a chance to reflect on today's move," said David Jones, chief market strategist at IG Index. (Editing by David Holmes)
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