By Nigel Stephenson
LONDON (Reuters) - European shares followed Asian stocks higher on Wednesday, buoyed by reports Italy would step in to rescue troubled bank Monte dei Paschi and expectations the European Central Bank would extend its bond-buying stimulus scheme this week.
Italian government bond yields fell, narrowing the premium investors demand to hold them rather than benchmark German debt, to its tightest for about a month.
The pan-European STOXX 600 index (STOXX) rose 0.8 percent, led by banks (SX7P), and Italy's FTSE MIB share index (FTMIB) gained 1.2 percent, hitting its highest for six months.
For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets
Shares in Monte dei Paschi, Italy's oldest bank and the focus of investor concerns over the country's banking sector, rose 9 percent (MI:BMPS).
Reuters reported exclusively on Tuesday that Italy was preparing to take a 2-billion-euro controlling stake in the bank as prospects of a private funding rescue faded following Prime Minister Matteo Renzi's decision to resign.
Investors' concerns were that a defeat for Renzi in a referendum on constitutional reforms could further undermine faith in the European Union - following Britain's decision to quit the bloc - as well as confidence in the euro currency.
Market reaction to Renzi's defeat and his resignations was relatively muted, partly as a consequence of a pledge by the ECB to buy Italian government debt if markets became unsettled.
"Despite the fact that the probability of early elections has risen, the market is focusing on the banking sector and the fact the government seems to be showing more urgency in dealing with that problem," Mizuho strategist Antoine Bouvet said.
Italian 10-year government bond yields
The euro
"People had gone into the referendum with a very pessimistic view and I think the last five years have taught us that, as far as the euro is concerned, political issues often don't have a lasting impact," DZ Bank currency analyst Sonja Marten said.
The dollar index (DXY), which measures the U.S. currency against a basket of six of its major peers, was marginally down on the day. The yen
Many market participants were looking to the ECB's policy meeting on Thursday, at which it is widely expected to announce an extension of its quantitative easing program. Uncertainty remains over whether the size of monthly purchases will be kept steady or scaled back, and over whether it will send a formal signal on the eventual end of the program.
One of the biggest movers in the currency markets was the Australian dollar, down 0.4 percent after data showed the Australian economy shrank by 0.5 percent, its biggest contraction since 2008, in the third quarter.
Australian stocks, however, closed 0.9 percent higher in anticipation of more fiscal and monetary stimulus. While rate futures <0#YIB:> imply scant chance of a Reserve Bank interest rate cut in the coming months, prospects of a hike vanished.
MSCI's broadest index of Asia-Pacific shares outside Japan (MIAPJ0000PUS) rose 0.4 percent while Japan's Nikkei (N225) added 0.7 percent. Chinese shares <.CSI300> gained 0.7 percent.
China's foreign exchange reserves fell by more than expected last month to $3.05 trillion, their lowest since 2011, the central bank said.
The yuan currency last stood at 6.8850 to the dollar
Oil prices fell as investors questioned whether a deal to cut output agreed last week by the Organization of the Petroleum Exporting Countries (OPEC) and others would be enough to drain that global glut that has pushed prices lower.
Brent crude, the international benchmark, fell 30 cents to $53.63 a barrel.
"Investors are torn between hopes that producers will cut enough production to balance supply and demand, and fears that they won't," brokerage PVM Oil Associates' senior analyst, Tamas Varga, said.