Slightly better economic news from China and Germany countered concerns over Europe's debt crisis on Tuesday, lifting European shares and the single currency, but Greek default fears and a looming debt sale by Spain held gains in check.
The latest survey of German economic sentiment, conducted by the ZEW think tank, posted its biggest ever monthly rise in January, easing fears of a recession in Europe's largest economy.
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The German data followed earlier numbers from China showing a much-feared slowdown in the world's second-largest economy was not as great as some had expected and still kept alive hopes for more policy easing measures from the government.
"Investors are happy to look through any longer term worries about Greek debt, and are anticipating some significant policy easing in China after the data released today to boost global activity into the spring of 2012," Andrew Milligan, head of global strategy at Standard Life Investments, said.
The strong reading on German business sentiment, while encouraging, still indicated tough times ahead for the euro zone's largest economy, economists said
"The (ZEW) index is still consistent with a majority of investors expecting economic conditions to deteriorate in future," Ben May of Capital Economics said.
"This is a worry given recent comments from the German statistical office which indicated that the economy contracted in Q4," he added.
But the news gave an instant boost to the euro, already stronger after the Chinese data earlier.
The euro jumped to a session high of $1.2800, roughly 1 percent higher on the day, and moved away from a 17-month low of $1.2624 hit last week.
European shares broke through technical resistance levels to hit fresh five-month highs after the ZEW news, to be up 1.1 percent at 1,037.17 points. The MSCI world equity index gained by around 0.9 percent after rising during Asian trade on the Chinese data.
DEBT FEARS LINGER
But behind positive economic sentiment growing worries about the prospect of a Greek debt default, which some fear could happen as soon as March when 14.5 billion euros of bond redemptions fall due, were never far away.
A growing number of experts, including a Standard and Poor's official, have warned a default was on the cards after Greece's talks with creditors broke down on Friday.
Greece is under growing pressure to secure a last-ditch agreement with its private creditors to accept voluntary losses on their holdings of Greek bonds.
"There is a lot of uncertainty about the euro zone. The downgrades were expected, but what the market is really concerned about are the Greek debt restructuring talks," said Ankita Dudhani, G-10 currency strategist at RBS.
Standard and Poor's late on Monday added to the euro zone's woes by downgrading the EFSF rescue fund by one notch to AA-plus, but coming after its downgrades for nine governments last week the move was widely expected.
A strong response to a Spanish Treasury bill auction on Tuesday also lifted sentiment ahead of an auction of bonds with maturities up to 10 years on Thursday .
Despite a two-notch cut in its rating by Standard & Poor's, the Spanish auctions should benefit from support from banks flush with European Central Bank cash and market perceptions the new government is serious about addressing its economic woes.
The ECB tender was a factor in a strong sale last week in which Spain perked up debt markets by selling 10 billion euros of bonds, twice the amount it targeted, at falling yields.
COMMODITIES GAINS ON CHINESE DATA
Commodity prices, mining stocks and commodity-related currencies all gained on hopes of greater economic activity after the Chinese GDP figures, with the Australian and New Zealand dollars hitting their strongest levels against the U.S. dollar in 2-1/2 months.
As the world's second-largest oil consumer, China's stronger-than-expected economic growth lifted Brent crude futures 77 cents at $112.11 a barrel, for a second day of gains.