10/05/2011 04:56 EDT | Updated 12/04/2011 05:12 EST

EU bank plan hopes help shore up Europe's stocks, but Dexia remains in the spotlight

LONDON - Stocks in Europe recouped some recent losses on Wednesday on hopes that European policymakers were thrashing out a plan to shore up the banking sector, which has been savaged of late over fears of a Greek debt default.

In an interview with the Financial Times newspaper, European Commissioner Olli Rehn hinted at a possible bank recapitalization plan. The comments started a stock market rally when they first emerged, late Tuesday on Wall Street. With an hour to go, sentiment turned around massively — from being nearly 2 per cent lower, the Standard & Poor's 500 index ended up over 2 per cent higher.

The upbeat finish on Wall Street failed to give Asian stocks much of a fillip but European markets rose in early trading, despite a three-notch downgrade of Italy's sovereign debt to A2 by the Moody's credit rating agency and another day of widespread strikes in Greece, the epicenter of Europe's debt woes.

"Traders on both sides of the Atlantic seem set to look for the positives here at least in the short term and with stocks once again trading down at discount levels, there may well be a temptation to start cherry picking some bargains," said Cameron Peacock, market analyst at IG Markets.

Germany's DAX was 2 per cent higher at 5,320 while the CAC-40 in France rose 2.3 per cent to 2,916. The FTSE 100 index of leading British shares was 1.9 per cent higher at 5,039.

The euro was also shored up by reports of a recapitalization plan, trading 0.1 per cent higher at $1.3325.

However, investors will be careful not to get too carried away. After all, sentiment has fluctuated wildly between despair and hope over the 21 months or so that Europe has been mired in its debt crisis.

"Whilst it is encouraging that EU leaders are addressing the perceived weakness of the financial system, it would not be unusual for the initial positive reaction to be followed by concern on delay and lack of agreement amongst member states," said Adam Cole, an analyst at RBC Capital Markets.

Franco-Belgian bank Dexia will be in the spotlight once again Wednesday amid mounting expectations that it will be broken up somehow, possibly this week.

Dexia is at the forefront of investor concerns over its exposure to potentially bad debt from Europe's most indebted countries. With the markets bracing for a Greek debt default soon, investors are concerned about what bonds Europe's banks are holding, and banks themselves have become reluctant to lend to one another.

At one point Tuesday the bank's share price plunged nearly 40 per cent, prompting France and Belgium to launch crisis-management initiatives designed to prevent a complete rout. It finished over 20 per cent lower on Tuesday.

Hopes that some sort of salvage operation will be mounted in the coming days has helped the stock rebound around 3 per cent in early trading Wednesday.

In Asia, the mood was less benign, with Japan's Nikkei index closing 0.9 per cent lower at 8,382.98 and Korea's Kospi index ending 2.3 per cent down at 1,666.52.

Stock markets in Hong Kong and mainland China were closed for a holiday.

The more buoyant tone in European stock markets helped oil prices rebound too. Benchmark oil for November delivery rose $2.53 to $78.20 a barrel on the New York Mercantile Exchange.