European shares close higher on U.S. debt hopes

LONDON (Reuters) - European shares ended higher on Thursday, snapping three consecutive days of losses on renewed hopes that the U.S. debt crisis will be resolved.

A late stage recovery was made on expectations a key vote to cut the U.S. deficit would be positive, while better than expected home sales and employment data in the world's biggest economy added to the support.

After the European market close, the White House said it was confident a compromise will be reached on the U.S. debt and deficits.

Banking stocks reversed early session falls to make them the best performers, with the STOXX Europe 600 Banks index .SX7P

up 1.3 percent.

The banking sector index had fallen 24 percent since mid-February, and now currently trades at 7.2 times 12-month forward earnings, a price-to-earnings ratio not seen since March 2009 during the financial crisis.

But weakness was seen in the chemical sector .SX4P, making it the worst performer in Europe following disappointing results from BASF (BASFn.DE) and Bayer (BAYGn.DE) and Belgium's Solvay (SOLB.BR).

BASF (BASFn.DE), the world's largest chemicals firm by sales, was the stand out loser, down 4.2 percent and topped the worst performer list on the Germany's DAX index .GDAXI.

Bayer and Solvay lost 1.2 percent and 3.3 percent respectively, with volumes for both stocks more than their 90-day daily average.

Siemens (SIEGn.DE), Europe's largest engineering group, was also on the German DAX worst performers list and lost 1.1 percent after third-quarter net profit was lower than consensus and it cautioned that global economic risks were increasing.

"Overall the general market outlook is gloomy, there has been a raft of poor earnings out of Europe and there are fears of slowing growth in the global economy hitting stocks," Mike McCudden, head of derivatives at Interactive Investor, said.

Trading was active in Vallourec (VLLP.PA) which dropped 16.9 percent, with volumes more than tenfold the 90-day daily average after the maker of seamless industrial tubes reported disappointing second-quarter results.

The pan-European FTSEurofirst 300 .FTEU3 index of top shares closed up 0.1 percent at 1,089.24 points, but has lost 1.8 percent so far this week on concerns about the U.S. debt talks.

Investors' appetite for risk showed signs it was fragile, with the Euro STOXX 50 volatility index .V2TX, Europe's main fear gauge up 2 percent.

The higher the volatility index, the lower investor appetite for risk.

EURO ZONE DEBT WORRIES

There were also still concerns that the euro zone debt crisis could spread beyond Greece to other, bigger countries, with Italian yields rising near 6 percent after a bond auction.

A Reuters asset allocation poll showed fund managers have reduced exposure to risk and cut positions in equities in July, while bond holdings rose to an 11-month high on concerns about the U.S. debt crisis and the euro zone.

"We are underweight European equities and not positioning for a rally," said Richard Batty, global investment strategist at Standard Life Investments, which has 157 billion pounds ($251 billion) of assets under management.

"Last week was only a short-term solution to Greece. There are concerns about debt in Italy and Italian spreads are widening which is extremely unhelpful." (Reporting by Joanne Frearson; Editing by Greg Mahlich)