European bank bailout soothes anxious markets

By Patrick Graham and Danilo Masoni

LONDON (Reuters) - A smoothly executed rescue of Spain's struggling Banco Popular drove European banking stocks higher on Wednesday in financial markets dominated by caution ahead of a trio of major events on Thursday.

The absorption of Popular by Spain's biggest bank Santander for a nominal one euro was the first use of a regime to deal with failing banks adopted after the 2008 financial crisis and made barely a ripple in Europe's stock and debt markets.

Indeed, as the morning wore on the success of the process pushed shares in many major banks higher, supporting a recovery for Madrid's stock market and fending off this week's broadly weaker mood.

There was some shock initially at the imposition of steep losses on junior bondholders and shareholders in Popular, but senior bondholders were spared. European banking shares rose 1.6 percent.

Wall Street was set to open flat to slightly higher.

"The market has taken Banco Popular as positive news because essentially this is not a bankruptcy but a sort of rescue, even if its subordinated bondholders have been sharply hit," said Giuseppe Sersale, a fund manager at Anthilia Capital in Milan.

"The fall in subordinated debt at other Spanish banks today lasted just around one hour. It's seen positively because it draws a line under (the problem) involving only risk capital."

ECB CUT?

The bank rescue does, however, underline the risks to growth, banking and government debt burdens that are likely to delay a major switch in language and policy direction by the European Central Bank at its meeting on Thursday.

The euro fell half a percent against the dollar in morning trade in Europe, spurred by a Bloomberg report that the ECB instead of flipping towards tighter policy would cut its inflation forecasts.

"Maybe tomorrow's ECB meeting sees nothing but platitudes and disappoints a market that is getting ahead of itself," said Societe Generale analyst Kit Juckes,

"But (for us) that would be a huge euro buying opportunity, because ECB normalisation IS coming. And when it does, the euro simply won't be able to sustain undervalued levels for long."

European blue chip shares had risen by just over half a percent by 1250 GMT and Madrid's IBEX recovered from early losses to trade 0.2 percent stronger on the day.

Oil prices, however, were again more than 1 percent lower and investors remain attracted by the perceived security of Japan's yen.

The yen rose half a percent against the euro and as high as 109.11 yen per dollar - its strongest in seven weeks - before steadying. The greenback has lost 1 percent so far this week, pressured by a sharp drop in U.S. Treasury yields to seven-month lows.

A surprisingly closely-fought British election set for Thursday is weighing on investors' minds along with U.S. Senate testimony from James Comey, the former FBI chief fired by President Donald Trump.

Any damaging revelations in Comey's testimony are likely to further hurt Trump and take the wind out of his plans to roll back regulations and overhaul the tax system - an agenda that had sent the dollar to 14-year highs earlier this year.

"Tomorrow is what is being dubbed as 'Triple Threat Thursday', ... an event-filled day that could send global markets on a bumpy ride," said ING currency strategist Viraj Patel.

(Editing by Gareth Jones and Mark Potter)