European stocks reverse losses as investors keep faith in Greek deal

By Lionel Laurent

LONDON (Reuters) - European stocks reversed early losses on Tuesday and yields on lower-rated euro zone bonds fell as investors reassessed the collapse of Greek debt talks and focused on the prospects of a deal.

The euro also recovered from early losses to rise against the dollar after Monday's breakdown of talks between Greece and euro zone finance ministers. Initial declines on equity markets were modest.

"For now, we assume that logic will prevail and this movie won't end in disaster," said Paul O'Connor, co-head of the multi-asset desk at Henderson Global Investors.

Both the euro zone and Greece raised the possibility of another attempt to find common ground before the end of this week. The European Central Bank is set to decide on Wednesday whether to maintain emergency lending to Greek banks, and the Greek state faces some heavy loan repayments in March.

Dutch Finance Minister Jeroen Dijsselbloem, who chairs the group of euro zone ministers, gave Athens until Friday to request an extension of its current bailout, which would otherwise expire at the end of the month.

The pan-European FTSEurofirst 300 equity index opened lower but was up 0.1 percent at 1300 GMT. U.S. shares were expected to open flat to lower, according to index futures.

Greek stocks underperformed. The volatile ATG main Athens share index was down 0.7 percent, after earlier dropping more than 4 percent and then briefly turning positive.

Yields on three-year Greek government bonds rose 83 basis points to 18.54 percent and 10-year yields rose 63 bps to 10.55 percent.

"The risk of a collapse is more elevated now because time is running out," said Patrick Jacq, rate strategist at BNP Paribas. "This is putting Greek government bonds under pressure, but contagion effects will remain relatively limited ... Eventually a deal is likely to be reached."

Yields on lower-rated euro zone debt edged lower, suggesting no fear of an imminent break-up of the bloc. Italian 10-year bonds yielded 1.63 percent, down 1.1 basis points, though Spanish 10-year yields edged up.

Without support from creditors, the Greek government and banks face a funding crunch. That might lead to Greece's becoming the first country to ditch the euro and re-introduce its own currency.

The MSCI all-country world stocks index was up 0.1 percent but still below the 4 1/2-month high it hit on Monday.

Earlier, Japan's Nikkei share average and MSCI's broadest index of Asia-Pacific shares outside Japan both dipped about 0.1 percent.

The euro traded weaker against the dollar in early European trade but later picked up to $1.1431, up 0.7 percent on the day.

"The market has witnessed this before -- it remembers the brinkmanship during the Greek debt negotiations of 2011," said Kyosuke Suzuki, director of forex at Societe Generale in Tokyo. "There are only nine trading days left until the Feb. 28 deadline, but some see that as enough time. Thus we are not seeing the euro sold in panic."

Gian Marco Salcioli, Head of FX Sales at the investment banking arm of Italy's Intesa Sanpaolo Banca IMI, said volumes had been subdued since the end of last week and that many exporters still expected the euro to head lower.

In commodities markets, Brent crude extended its recent rally and last traded at $61.97 a barrel as the International Energy Agency warned of supply risks in the Middle East, although some analysts said that prices had risen too far from the six-year lows hit in January.

The crude rally helped support the Russian rouble, which also benefited from political efforts to make a ceasefire hold in eastern Ukraine, although gains were capped by doubts about whether the ceasefire would hold.

(Additional reporting by Nigel Stephenson and Marius Zaharia in London; Editing by Larry King)