European Stocks Edge Higher on Debt Deal Hopes

European stocks edged higher on Friday, keeping the previous day's rally alive, while investors waited to see if an agreement would finally be reached in Washington on the U.S. debt ceiling.

At 1030 GMT, the FTSEurofirst 300 index of top European shares was up 0.4 percent at 1,250.14 points, after surging 1.7 percent on Thursday.

The euro zone's blue-chip Euro STOXX 50 index was up 0.1 percent at 2,973.62 points, hitting a new 2-1/2 year high.

Stocks around the world had lost ground in the past three weeks after an impasse in U.S. budget talks led to a partial government shutdown and sparked concerns about the extension of Washington's borrowing authority beyond an Oct. 17 deadline.

On Thursday, President Barack Obama and Republican leaders appeared ready to end the deadlock. One senior Republican said an agreement could come on Friday.

"The question is: what kind of deal will be reached? A temporary solution would just mean more negotiations in the weeks to come and more stress for markets, so we're not out of the woods yet and the risk of a U.S. credit downgrade remains," said David Thebault, head of quantitative sales trading at Global Equities.

"The fact that the biggest economy in the world struggles to raise its borrowing limit is also putting the spotlight back on other countries which struggle with their debt," said Thebault, who recommends buying put spreads to hedge stock portfolios "at least until December".

Around Europe, Germany's DAX index was up 0.3 percent on Friday, and France's CAC 40 up 0.1 percent.

Britain's FTSE 100 index, whose companies have a significant exposure to the U.S. economy, was up 0.7 percent, with GlaxoSmithKline up 1 percent and Unilever up 1.1 percent.

The Euro STOXX 50 Volatility index, known as the VSTOXX, was down 7 percent, indicating a drop in investors' risk aversion. Europe's widely-used gauge of investor sentiment, which is based on put and call options on Euro STOXX 50 stocks, has fallen 21 percent since a peak hit on Wednesday.

"Even though investors get nervous when political tensions rise, the backdrop for equities remains quite positive: very accommodative central banks, improvement on the macro front, and relatively good corporate fundamentals," said Jeanne Asseraf-Bitton, head of global cross-asset research at Lyxor Asset Management, which has $98 billion under management.

"It's sort of a 'sweet spot' for stocks. Now, with the earnings season set to start, we need to see an improvement in the earnings momentum. It has improved lately in Europe, although it remains negative for now."

Europe's earnings momentum - analyst forecast upgrades minus downgrades as a percentage of total - has recently improved, from minus 3.2 percent in July to minus 2.1 percent currently, data from Thomson Reuters Datastream shows.