European shares rally on report ECB mulling corporate bonds buys

(Updates with closing prices)

* FTSEurofirst 300 up 2.1 pct

* Rallies as Reuters reports ECB considering corporate bond buys

By Francesco Canepa

LONDON, Oct 21 (Reuters) - Banks and shares in peripheral countries led a European rally on Tuesday after sources told Reuters the European Central Bank is considering buying corporate bonds to revive the region's economy.

The purchases, which the sources said could be approved in December and start early next year, are seen as helping banks, especially in struggling southern European countries, free up more of their balance sheet for lending.

The Euro STOXX banking index rose 3.3 percent, with the biggest gains seen in Greek, Italian and French banks.

The ECB began buying covered bonds on Monday, part of a private-sector asset-purchase programme that will also see it buy bundled loans known as asset-backed securities (ABS) later this year. However, there is concern at the ECB that these measures may have an insufficient impact to help support the economy.

After a year-long review of Europe's 130 biggest banks, the ECB is set to announce on Oct. 26 which have valued their assets properly and which have not, as well as whether banks need more capital to withstand another economic crash.

"(Corporate bond purchases) would help alleviating some of the pressures which weigh on the banks' balance sheet and that needs to be seen in the context of the upcoming asset quality review," AXA Investment Managers' chief strategist Franz Wenzel said.

"It would also help those corporates and those regions which were having difficulties in issuing corporate bonds, and I'm thinking of the south."

The FTSEurofirst 300 index of top European shares closed 2.1 percent higher at 1,299.26 points, extending its bounce from a 13-month low hit on Thursday.

GROWTH WORRIES

Investors have been worrying about a deterioration in the pace of economic growth in Europe and other regions, such as China. These concerns were underscored by data on Tuesday showing China's economic growth slowed in the third quarter to its weakest since the 2008/09 global financial crisis.

"The main trend is still negative. Volatility is falling back but remains at a high level. We're in a technical bounce and the market is vulnerable," said Jean-Louis Cussac, head of Paris-based firm Perceval Finance.

"In this context, selling all the rebounds is a good strategy to benefit from the swings."

German engine maker Deutz (Xetra: 630500 - news) fell nearly 10 percent after it scrapped its 2014 operating profit forecast, citing unexpected costs related to warranties and goodwill for engines from the DEUTZ Compact Engines segment, primarily built in 2011.

Shares (Berlin: DI6.BE - news) in Actelion (Xetra: 936767 - news) gained 3 percent after it raised its full-year profit guidance for the second quarter in a row, buoyed by a healthy uptake of its new heart and lung drug.

Portugal Telecom sank again, down 8.2 percent as investors continued to dump the shares following the bankruptcy of Espirito Santo holding company Rioforte which has raised the risk Portugal Telecom will not recover 900 million euros ($1.2 billion) in debt from the company.

The stock has been tumbling in recent weeks on mounting uncertainty over the company after the resignation of chief executive Zeinal Bava from PT's Brazilian partner Oi and reports that Oi (NYSE: OIBR - news) could sell its Portuguese assets. (Additional reporting by Blaise Robinson in Paris; Editing by Alison Williams)