Prospects that U.S. equity markets would bounce back on Wednesday after two days of falls lifted European markets, suppressing fears about weakness in the U.S. economy and global financial system.

In the kind of see-saw trading that has become common among investors over the past month, the FTSEurofirst 300 index of top European shares rose into positive territory after spending most of the morning session with losses.

Safe-haven bonds, however, continued to find demand while profit-taking was a feature on currency markets.

Such volatility reflects investors balancing on an almost day-to-day basis the pull of cheaper shares and solid global economic growth against worries that U.S. mortgage problems could bring as yet unquantified losses to financial institutions and spill over into the wider economy.

It is still an environment where risk perception is the main market driver, said Niels From, currency strategist at Dresdner Kleinwort.

Wednesday's early stock losses were triggered by news in the previous session that U.S. consumer sentiment had taken its steepest plunge in nearly two years and that Merrill Lynch was downgrading ratings on major U.S. banks, due in part to ailing credit markets.

Separate data on U.S. house prices also showed the worst decline in at least 20 years, adding to fears of a slowdown in U.S. consumption, which drives about 70 percent of the world's biggest economy.

Investors, however, have been keen to find bargains in stocks after steep falls in early August. Wall Street looked set to open higher, driven by such sentiment.

There are several places where you're going to see bargain hunting, including in the financials, said Andrew Seibert, senior portfolio manager at Stewart Capital in Pittsburgh, Pennsylvania.

The pan-European FTSEurofirst 300 index was up around 0.2 percent.

But MSCI's main world index was down 0.2 percent on the day after falls in Japan and among emerging markets. MSCI's emerging market benchmark was off 0.7 percent.

Earlier, Japanese stocks hit their lowest close in a week after earlier falling by nearly 3 percent.

The benchmark Nikkei average lost 274.66 points or 1.69 percent to 16,012.83. The broad TOPIX index ended down 1.7 percent at 1,557.55.

CURRENCIES, BONDS

The yen weakened as investors, calmed by stabilizing stock markets, locked in profits from a risk-aversion fuelled rally in the Japanese currency, which has become something of a proxy for risk because of its role in the carry trade, where investors sell yen to buy assets in higher-yielding currencies.

The dollar was up 0.5 percent at 114.78 yen, rebounding from an earlier one-week low of 113.88. The euro added 0.7 percent to 156.44 yen.

The euro was up around a quarter of a percent at $1.3632.

Euro zone government bond futures pushed higher on safe haven plays.

The September Bund future rose above the psychologically significant 114.00 level and was 16 ticks higher at 114.03.

The two-year Schatz yield was at 3.979 percent while 10-year paper was yielding 4.204 percent, down 1.5 basis points, according to Reuters data. Bond yields move inversely to prices.

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