By Francesco Canepa
LONDON (Reuters) - Euro zone blue chips rallied in thin volume on Monday as banks led a technical rebound, strengthened by signs Spain was opening the door to using public funds to aid its troubled lenders.
The Euro STOXX 50 index <.STOXX50E> closed 34.75 points higher, or 1.6 percent, at 2,283.09, having traded around 90 percent of its 90-day average as the UK and Irish markets were shut for public holidays.
The index recouped a little over a third of the nearly 100 points dropped last week, when worse-than-expected U.S. economic data dampened hopes that growth in the world's largest economy would drive corporate earnings in crisis-struck Europe.
An initial, negative reaction to election results in France and Greece had sent it to a 4-1/2 month low of 2,204 early on Monday, leaving the gauge in oversold territory on the 7-day relative strength index before a rebound, Thomson Reuters data showed.
The up-move was led by banks <.SX7E>, which rose 3.5 percent after bouncing off a strong technical support at 85, its 2009 low, triggering short covering on the sector, traders and analysts said.
"We just had a bear trap this morning on the Euro STOXX 50," said Nicolas Suiffet, an analyst at Paris-based technical analysis firm, Trading Central, referring to a situation where expectations that a rising market trend will prove temporary and that the previous bear market will resume turn out to be false.
"As long as 2,204 is not penetrated, look for choppy price action with a bullish bias," Suiffet added.
Spanish banks were among top gainers, with leaders Banco Santander and BBVA up 4.7 percent and 5.4 percent respectively as Prime Minister Mariano Rajoy said public money could be used as a last resort to aid domestic lenders.
Italy's UniCredit led sector gainers with local traders citing short covering ahead of the Italian banks' first-quarter earnings season, due to start this week.
"Trading incomes will come in high so you're getting some short covering at these levels," a Milan trader said. "The move could be fairly sharp, but perhaps brief."
Heavyweight financials helped Spain's Ibex 35 <.IBEX> and Italy's Ftse MIB <.FTMIB> outperform their peers as the two Southern European gauges rose 2.7 percent and 2.6 percent, respectively.
France's CAC-40 <.FCHI> closed up 1.7 percent after a lower start as investors took the view that president elect Francois Hollande, who promised to renegotiate Europe's austerity pact if elected, would not bring about too drastic policy changes.
"Hollande's victory was probably priced in and I would doubt that all the things he said during the elections would be implemented," Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels. "Markets will certainly keep him in line."
Markets had had two weeks to get used to a Hollande victory after he took the lead in the first round of the polls in April.
Builders Lafarge and Bouygues were among top gainers on the CAC-40, rising 4 percent and 3.8 percent, as investors expected government spending on social housing to increase under the president, in line with Hollande's election pledges.
On the downside, shares in Greek banks fell more than 12 percent, sending Athens General Index <.ATG> down 6.7 percent, after the only two major Greek parties to have supported an EU/IMF bailout programme failed to win enough votes to form a ruling coalition <.FTATBNK>.
This cast doubt on Greece's ability to avert bankruptcy and stay in the euro.
"The result of the elections was the worst that could be expected: it seems highly unlikely that we're going to have a government now," the head of institutional trading at a major Greek bank said.
"Until (a government is formed), uncertainly will prevail and some people will feel uneasy and decide to liquidate their holdings in Greece."
In a reminder of the other challenges still facing Europe, the world's largest chemical maker by revenue, Germany's BASF , fell 0.9 percent after saying it believed southern Europe was in a recession and expected the continent's economy to barely grow this year.
(Additional reporting by Toni Vorobyova; editing by Ron Askew)