Investor concerns over Italy and Spain eased on Monday on hopes that the eurozone authorities would act to lower borrowing costs.
Spain’s 10-year borrowing costs dropped to 6.5 per cent from last week’s record high of 7.5 per cent, reflecting a slightly improvement in investor confidence.
Italy paid a lower rate of interest at a bond auction to raise 5.48bn euros (£4.2bn).
The US Treasury Secretary is also arriving in Europe for talks later.
Italy’s bond auction saw it offload its 10-year bonds at an interest rate of 5.96 per cent, the first time it has sold them below 6 per cent since April.
However, Richard McGuire, a rate strategist at Rabobank, said the interest rate Italy was paying to sell its debt was still too high.
“While these sales do provide some indication of an easing of tensions at the periphery, they also show considerable further progress on this front is needed,” Mr McGuire added.
Meanwhile, official data showed that Spain’s economy shrank 0.4% in the second quarter of the year. That compares with a 0.3 per cent contraction in gross domestic product (GDP) in the first three months of the year.
The national statistics institute INE, which published the figures, said the worsening GDP figures reflected “weaker domestic demand”.
Nonetheless markets rose, boosted by continued speculation that action will be taken by eurozone authorities to cut borrowing costs for countries such as Spain and Italy.
Spain’s Ibex 35 index was up 1.6 per cent France’s Cac-40 up 0.8% and Germany’s Dax up 0.4 per cent.
However, Commerzbank rate strategist Rainer Guntermann cautioned that the market rally may not continue.
“Expectations are high... but for the rally to continue we may need more colour, more details and maybe some action,” said Mr Guntermann.
US Treasury Secretary Timothy Geithner is in Europe for talks with German Finance Minister Wolfgang Scheauble, boosting hopes of imminent action. Mr Geithner will also have discussions with ECB president Mario Draghi.
German finance ministry spokeswoman Marianne Kothe attempted to dampen speculation, insisting that the talks would only be informal.
Eurogroup leader Jean-Claude Juncker, who has called for the European Central Bank (ECB) to act to cut Spain’s debt costs, told German and French press in interviews published late on Sunday: “We will work in close agreement with the ECB, and we will, as ECB President Mario Draghi said, see results.
“I don’t want to drive expectations, but I must say, we have reached a decisive phase.”
On Thursday, the ECB will announce its latest decision on interest rates and there is speculation that it may also announce that it is restarting its bond-buying programme, known as the Securities Markets Programme (SMP).
Under the SMP, the ECB buys government debt from banks on the commercial market, which helps to bring down the cost of borrowing for governments without the ECB having to lend directly to them.