By Richard Hubbard
LONDON (Reuters) - European stock markets and the euro extended two months of gains on Thursday as Greece edged closer to a bailout deal and investors bet a brace of central bank meetings would offer further support for the move into riskier assets.
Disagreement among Greek politicians over pension reform is the last hurdle to securing a second bailout for Greece and avoiding a chaotic debt default in March. Hopes are high a way will be found around the issue at a euro zone finance ministers meeting later in the day.
The single currency, which briefly hit a fresh two-month high of $1.3313 in late Tokyo trade on expectations the Greek deal would get done, was up around 0.3 percent at $1.3298.
"Short-term optimism played out and the euro went above $1.33 on the view that there would be a deal sooner rather than later," said Jeremy Stretch, currency strategist at CIBC.
The pan-European FTSEurofirst 300 <.FTEU3> index of top shares was initially held back by disappointing results from Dutch bank and insurance group ING
Markets have been in optimistic form since the European Central Bank flooded banks with almost half a trillion in cheap loans in late December, with the opening of a new year which allows investors to relaunch bets adding to the trend.
However, a jump in Spanish bond yields, after the government
surprised markets by selling an extra 4 billion euros of 10-year on Wednesday, rattled bond markets and highlighted the fragility of the sentiment behind the rally.
The jump in Spanish debt yields spread to the Italian debt market and saw prices for safe-haven German government bonds also erased some of their early losses. The March Bund future, which had been down as much as 23 ticks, recovered to be 13 ticks lower at 137.71.
Central bank balance sheets as percentage of GDP: http://link.reuters.com/jyx65s
Greek economic overview: http://link.reuters.com/rup24s
Asset Performance in 2012: http://link.reuters.com/muc46s
CENTRAL BANKS IN FOCUS
The ECB is not expected to change interest rates at Thursday's monthly policy meeting while it waits for the outcome of a second, large three-year loan tender due at the end of the month.
But it will face a grilling on what it can do to help Greece and markets will scrutinize governor Mario Draghi's comments for confirmation it will lower rates soon.
The next tender, which is expected to be nearly as big as that in December, will represent a rapid expansion in the ECB's balance sheet as it battles to help resolve the euro zone debt crisis, which itself could worry the markets.
"I suspect this risk rally may have a little further to run - until people realize that the expansion of the ECB's balance sheet is not a positive and the debt dynamics of Greece are not sustainable," said CIBC's Jeremy Stretch.
The Bank of England, which also meets later, is likely to inject more cash into the UK economy to shore up a stuttering recovery, despite signs that the country may have avoided slipping back into recession.
Brent crude held near six-month highs above $117 on hopes that demand would pick up as Greece inched closer to getting its debt crisis under control, while concerns over supply disruption from the Middle East provided support.
Front-month Brent crude gained 20 cents to $117.40 a barrel to mark it eighth straight day of gains.
Earlier news that China saw a faster-than-expected annual inflation rate of 4.5 percent in January, above a 4.1 percent rise forecast, had a muted impact on markets.
The outcome dampened expectations of an imminent move by the central bank to cut banks' required reserve ratios (RRR), the level of cash they must hold in reserve.
(Additional reporting by Jessica Mortimer. Editing by Anna Willard and Patrick Graham)