Shares hit seven-week high on hopes of eurozone deal

Hopes are mounting that politicians are finally moving closer to a deal following intensive talks in Brussels at the weekend.

Members of the German parliament last night suggested the package would involve increasing the firepower of the European bail-out fund beyond €1 trillion (£869 billion), while a major recapitalisation of banks – to the tune of €108bn (£94bn) – is also understood to be on the table.

Italian premier Silvio Berlusconi – who received stern words from the French and German leaders over the weekend – has convened his cabinet to come up with a package of plausible growth measures by tomorrow, as demanded by European Union leaders. Italy is seen as the next likely victim in the debt crisis, but the third-largest eurozone economy would be too expensive to bail out.

The FTSE closed up 1 per cent at 5,548 while Wall Street also made gains in early trading despite worrying evidence that the eurozone is moving dangerously close to a second recession. The latest Purchasing Managers’ Index (PMI) for the eurozone showed a further deterioration in conditions, with the survey reaching its lowest level since July 2009.

Economists highlighted that the problems weren’t restricted to the so-called periphery countries either – and France saw the first fall in private sector output for more than two years.

Chris Williamson, chief economist at research group Markit, which produces the index, said: “The PMI signals a heightened risk of the eurozone sliding back into recession. The economy started the fourth quarter with the rate of contraction accelerating to the fastest since July 2009.

“Forward-looking indicators, such as the further lowering of expectations of services growth in the year ahead and the near-stalling of job creation, suggest that companies are bracing themselves for the situation to continue to deteriorate.”

IHS Global Insight economist, Howard Archer, said the 17-country bloc was in “grave danger” of sliding back into recession. He urged policymakers in the region to take “a quantum leap forward” this week in resolving the crisis.

Despite recessionary fears in Europe, however, the markets also found comfort in manufacturing data from China, which pointed to a rebound in the sector following a three-month contraction. The positive figures helped to alleviate concerns over the world’s second biggest economy slowing down and stoked a rise in commodity prices.

It is hoped that tomorrow’s summit will bring to an end weeks of uncertainty and political squabbling over how to guide the eurozone on to a more stable footing. The extent to which the European Central Bank (ECB) has been trying to put out fires while the political negotiations take place was laid bare yesterday with details of its bond purchases in recent weeks.

The ECB has been soaking up bonds of weakened European countries on the open market in an effort to keep bond prices up and reduce the interest payments nations have to make in order to borrow on the international money markets.

The bank revealed that it bought €4.5bn in government bonds last week, up from €2.2bn the week before, meaning that the total value of sovereign bonds held by the central bank is now €169.5bn.

Although market sentiment was on the positive side, traders pointed out that it was a nervous optimism. John Douthwaite, chief executive of SimplyStockbroking, said: “The market is crying out for some good news, but this is tempered by caution as another false dawn would be a disaster.”

Some of those anxieties were voiced on the Greek stock exchange, as bank shares plummeted on expectations that the new eurozone deal will lead to higher than agreed losses on the country’s government bonds.