European shares rose on Friday in a tentative relief rally, recouping some of the losses in the previous session after a majority of European leaders agreed to work towards stricter budget discipline at a crucial summit. Stocks also got some support after a source with knowledge of the matter told Reuters that China's central bank was creating a new vehicle to manage two investment funds, with one targeting the United States and the other Europe.
The EU deal, which was not backed by Britain, was short of any immediate, extra measures to ease the eurozone debt crisis, making fund managers wary about increasing long-term holdings in risky assets, however. Banks, which have been a focus of the eurozone debt crisis due to their exposure to the region's debt, were the best performers in Europe following the deal, with the STOXX Europe 600 Banks index up 2.6 percent. Italian banks, among the worst hit on Thursday after the ECB did not signal it would increase its bond-buying programme to struggling economies like Italy, were some of Friday's best performers.
UniCredit and Intesa Sanpaolo, which have heavy exposure to Italian debt and have been impacted by struggling growth in Italy, rose 7.1 percent and 7.9 percent respectively after falling 7.2 percent and 8.9 percent on Thursday. The banks led the gains on the Italy's FTSE MIB, which rose 3.4 percent to make it the best performing index in Europe after dropping 4.3 percent in the previous session. "Lets hope this is the one that resolves the crisis, but I think the gains are only a relief rally," said Andy Lynch, fund manager at Schroders, which manages $307.93 billion.
Negotiations to draft the new treaty for deeper economic integration could take three months and may require countries to undertake risky referendums. "The implementation is going to be difficult and we are still underweight financials. Banks remain in a difficult place, the European economy is slowing quite sharply and that will result in more bad debts and write downs," Lynch said.
The pan-European FTSEurofirst 300 index of top shares closed up 1.3 percent at 985.81 points after falling 1.5 percent in the previous session after ECB President Mario Draghi dampened hopes the central bank would increase bond purchases. The Euro STOXX 50 volatility index, a key gauge of Europe's investor 'fear', fell 11.4 percent and hit a six week closing low - the higher the volatility index, the lower investor appetite for risk. Fund flow information showed investors were not yet quite prepared to commit to the market.
Investors have been cutting their overall equity exposure to the eurozone throughout the fourth quarter, according to data from EPFR Global, which tracks fund flows and asset allocation data, and flows have remained negative despite the strong stock market rally started in late November. "Daily flow data during the fourth quarter suggests investors are losing patience with the eurozone's inability to contain its long running crisis," EPFR said in a note.