European shares extend gains, Novartis rallies

* FTSEurofirst 300 gains 0.2 pct, hits 3-week high

* Euro zone's Euro STOXX 50 index sets 5-1/2-year peak

* Novartis (Xetra: NOT.DE - news) rises on positive results for heart drug

* Miners top sectoral gainers, Italian banks rally

By Atul Prakash

LONDON, March 31 (Reuters) - European equities hit a three-week high on Monday, with Novartis stronger due to good results for its heart drug and miners performing well on expectations that China might stimulate its economy.

Swiss drugmaker Novartis, up 3.6 percent, added the post points to the FTSEurofirst 300 index after saying it has ended a late-stage clinical trial of a chronic heart failure drug early, following strong interim results.

Among big sectoral movers, the STOXX Europe 600 Basic Resources index rose 0.5 percent on speculation of new stimulus measures in China, the world's biggest metals consumer, with Chinese Premier Li Keqiang saying that Beijing was ready to support the cooling economy.

At 1125 GMT, the pan-European stock index was up 0.2 percent at 1,334.45 points after touching 1,340.73, the highest since early March. The euro zone's blue-chip Euro STOXX 50 was flat after hitting a 5-1/2-year high of 3,185.67.

However, investors stayed cautious in trading stocks on the last day of the quarter and ahead of events later this week that could set the market's near-term direction. Focus will be on the European Central Bank's policy meeting on Thursday and U.S. jobs data on Friday.

"It is the last trading day of the quarter and the market appears to be treading water ahead of the ECB's policy meeting and the market sensitive economic numbers from the United States, such as ISM and non-farm payrolls," Robert Parkes, equity strategist, HSBC Securities, said.

Expectations that the ECB will take radical action to stop the threat of deflation in the currency bloc rose after data showed euro zone inflation hit its lowest level since November 2009 in March.

ITALIAN BANKS GAIN

Among other sharp movers, Italian banks led financial stocks higher on news that they will not require any state funds. Shares in Monte dei Paschi (Milan: BMPS.MI - news) di Siena, Intesa Sanpaolo (Frankfurt: IES.F - news) and UniCredit (Berlin: CRIH.BE - news) rose 1.4 to 8.8 percent.

Banco Popolare (Dusseldorf: B8Z.DU - news) spiked 7.8 percent on the first day of a 1.5 billion euro ($2.06 billion) capital increase which according to the Italian press has attracted interest from international investors.

Italy's FTSE MIB, up 0.6 percent, rose more than other major indexes, with Credit Suisse (NYSE: CS - news) strategists seeing further gains saying the country's potential reforms should boost economic recovery while credit conditions are easing.

Italian stocks, which have strongly outperformed broad European stock indexes as well as U.S. markets so far this year, are still the cheapest stocks in Europe in terms of book value, according to data from Thomson Reuters Datastream.

Italian shares trade at 1.02 times book value, while Swiss stocks trade at 2.75 times book value, and overall European stocks trade at 1.85 book value.

Analysts said the broader market's outlook remained positive and key indexes, such as the Euro STOXX 50, could set new highs in the medium term, but caution is required in the short-run. The blue-chip index's 5-1/2-year high on Monday is about 7 percent higher since a low hit in mid-March.

"The index's outlook is positive for the time being. Ideally we want to see a close above January highs. I will be a little bit cautious on its sustainability and would like to see if the recent rally is because of the month-end flows," Lynnden Branigan, technical analyst at Barclays Capital, said.

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

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

Today's European research round-up (Additional reporting by Blaise Robinson in Paris; Editing by Angus MacSwan)