* Euro STOXX 50 index sets 5-1/2-year high, up 0.3 pct
* FTSEurofirst 300 up for 5th straight session, up 0.4 pct
* Italian banks rally on Popolare, Monte Paschi boost
By Francesco Canepa
LONDON, March 31 Italian banks helped European shares rise for a fifth straight session on Monday, with a euro zone index setting a 5-1/2 year peak as the market welcomed signs that smaller lenders are boosting their capital and winning over international investors.
Sentiment was also supported by expectations of new stimulus measures from the European Central Bank, which were cemented by lower-than-expected euro zone inflation data on Monday.
Italian mid-tier banks Banco Popolare and Monte Paschi were the top risers on the STOXX Europe 600 index, surging 9.9 percent and 7.6 percent respectively compared with a 0.4 percent rise for the whole index.
Banco Popolare was boosted by reports that it had attracted foreign investors to its capital increase, while Monte Paschi saw two big Latin American funds take stakes ahead of the bank's own cash call, a sign of growing confidence in the sector and in the Italian economy from international investors.
"This round of capital increases is seen as a reinforcing element for banks in the context of a more stable economic environment," said Roberto Brasca, who manages a pan-European equity fund for AcomeA and is overweight smaller Italian lenders.
"Once these banks have sorted themselves out in terms of capital ratios, they can use their resources to lend."
A raft of price target upgrades by investment banks boosted Italian lender Intesa Sanpaolo, which added 3.2 percent to feature among top risers on the Euro STOXX 50 index index.
The euro zone blue chip index increased 0.3 percent to 3,180.76 points at 1530 GMT, having hit its highest level since 2008 at 3,185.68 points. The pan-European FTSEurofirst 300 index rose 0.4 percent to 1,337.16 points, taking its quarterly gains to 1.6 percent.
Italy's FTSE MIB, up 1 percent on Monday, has outperformed both indexes so far this year as Italy emerges from a deep two-year recession and the new government of Prime Minister Matteo Renzi raised expectations for long-awaited economic and political reforms.
Credit Suisse strategists expect further gains in Italian stocks, saying the reforms should boost the economic recovery. It noted credit conditions are easing and the shares' valuations are still the cheapest in Europe.
Elsewhere on European equities, investors stayed cautious on the last day of the quarter and ahead of events later this week that could set the market's near-term direction. Investor focus will be on the European Central Bank's policy meeting on Thursday and on U.S. jobs data on Friday.
Data on Monday showed inflation in the euro zone fell to its lowest level since 2009, fuelling speculation the ECB may sooner or later take radical action such as the launch of quantitative easing (QE) to tackle the threat of deflation.
"(The) chances of an additional rate cut and potentially QE after that have clearly increased," said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels.
"This should be longer-term positive for European equities. Today the end of quarter rebalancing is potentially clouding this trend."
Europe bourses in 2014: link.reuters.com/pap87v
Asset performance in 2014: link.reuters.com/gap87v
Today's European research round-up (Additional reporting by Atul Prakash in London and Blaise Robinson in Paris; Editing by Gareth Jones)