Europe shares rally as fear of Ukrainian escalation eases

* FTSEurofirst 300 up 1.1 pct, bounces from Friday's dip

* Rebound led by German blue-chips

By Blaise Robinson

PARIS, Aug 18 (Reuters) - European shares rallied on Monday morning as the threat of wider conflict in Ukraine seemed to diminish.

In what may be a breakthrough in Ukraine's campaign against pro-Moscow separatists, government forces raised their national flag over a police station in the city of Luhansk that was for months under rebel control.

Also reassuring investors, Russia's Foreign Ministry said on Monday a 'certain progress' was achieved during talks among Russia, Germany, France and Ukraine in Berlin on Sunday.

At 0745 GMT, the FTSEurofirst 300 index of top European shares was up 1.1 percent at 1,338.02 points. Germany's DAX was up 1.4 percent.

German blue-chips - considered the most vulnerable to the tensions between the West and Russia - were among the top gainers on Monday. BASF rose 2.2 percent and both Bayer (Milan: BAY.MI - news) and Siemens gained 1.9 percent.

The pan-European index had lost 0.5 percent and Germany's DAX had dropped 1.4 percent on Friday, when reports that Ukrainian forces had destroyed a Russian military column in Ukraine sparked fears the conflict was escalating.

"Friday's news spooked investors, but it turns out that there was no escalation involving Russian forces over the weekend and that rebel forces have actually been retreating, which helps the market reverse losses," Saxo Bank trader Pierre Martin said.

"Investors want to believe in this rebound that started early last week after a 10 percent correction, so we're seeing buyers of the dip."

Also helping sentiment on Monday, Kurdish fighters pushed to retake Iraq's largest dam on Sunday and the United States conducted a second day of air strikes against Islamic State insurgents who have overrun much of the country's north.

The FTSEurofirst 300 had lost as much as 7.4 percent and Germany's DAX as much as 11 percent between late June and early August. The losses came amid fears that the Ukrainian conflict and tensions between the West and Moscow could derail Europe's fragile economic recovery and hit corporate results.

Stocks started to recover last week, however, with the FTSEurofirst gaining 1.4 percent over the week despite Friday's pull-back.

Europe bourses in 2014: http://link.reuters.com/pap87v

Asset performance in 2014: http://link.reuters.com/gap87v

Today's European research round-up

(Editing by Larry King)