Euro, stocks rise on Germany hopes; capped by crisis

European shares and the euro rose on Tuesday on unexpectedly good news about the German economy's prospects, but concerns about problems policymakers are having in tackling the euro zone debt crisis limited gains.

German business sentiment rose in December helped by solid consumer demand in the run up to the Christmas holiday, the Munich-based Ifo think tank said.

The business climate in retailing and domestic construction has improved, said Klaus Abberger, the survey's coordinator.

At the moment I don't think we (Germany) will fall into recession again.

The euro was up about 0.3 percent to $1.3040, away from Monday's low of around $1.2983 and having hit an 11-month low of $1.2944 last week.

European shares <.FTEU3> reversed early losses to be up about 0.25 percent after the survey's release, temporarily ending a two-week slide, while the MSCI world equity index <.MIWD00000PUS> gained around 0.2 percent after starting flat.

Sentiment remains fragile towards the euro, said Simon Derrick, head of currency research at Bank of New York Mellon.

You just need another piece of bad news and the euro will nudging closer to its 2011 lows, he said.

Euro zone ministers agreed on Monday to boost the IMF's resources by 150 billion euros to help tackle the region's two-year old debt crisis, but it was unclear if the bloc would reach its overall 200 billion euro target after Britain bowed out.

The increase in the IMF resources was seen as a vital part of Europe's steps to prevent the crisis from spinning out of control given worries that the region's scheduled permanent bailout fund is too small to handle the debt problems.

The markets remain focused on debt funding costs that have risen sharply for many EU nations.

European Central Bank President Mario Draghi told European Parliament on Monday that the ECB's purchases of peripheral debt were temporary, disappointing investors who were hoping for further bond buying that would keep yields stable.

He also said 2012 will be a difficult year for the euro zone's banks, and recovery is likely to be slow.

ECB FUNDS KEY

Attention is now switching to Wednesday's first offering by the ECB of low-cost, three-year funds to the region's banks, which some hope will encourage them to buy high-yielding Spanish and Italian bonds while other believe will instead be used to repair balance sheets.

A Reuters poll showed euro zone banks were expected to snap up 250 billion euros at the tender, although forecasts ranged from 50 to 450 billion euros, indicating a high degree of uncertainty.

Italian and Spanish bond yields fell on the hopes that banks will borrow a large amount of the ECB's three-year funds and buy the higher-yielding bonds issued by the two countries.

That was reflected in a sharp drop in Spanish short-term financing costs at auction.

Italian 10-year yields fell 10 basis points to 6.76 percent, narrowing the difference to safe-haven German bunds to 485 basis points.

Earlier the mood in Asian markets was still risk-averse, after the death of North Korean leader Kim Jong-il raised fears of regional instability, though share market recovered much of Monday's losses.

Tokyo's Nikkei share average <.N225> ended up 0.5 percent, moving away from Monday's three-week low<.T>, while South Korea's benchmark index <.KS11> outperformed with a 0.7 percent rise, after plunging as much as 5 percent on news of Kim's death. <.KS11>

Market players said thin pre-holiday trade may exaggerate price swings, but further heavy selling was unlikely until there was another catalyst, such as European sovereign ratings cuts.

In the oil market Brent crude futures rose to around $104.85 a barrel, lifted by the risk of supply being disrupted from Central Asian oil producer Kazakhstan, even as sanctions-hit Iran struggles to maintain its production and Libyan output is delayed.

(Additional reporting by Anirban Nag; Editing by John Stonestreet)