By Shreyashi Sanyal and Devik Jain
(Reuters) -European shares rose on Thursday led by gains in bank stocks after the European Central Bank delivered its biggest-ever interest rate hike to combat inflation, which is running at a half-century high and approaching double-digits.
The ECB raised its benchmark lending rate by 75 basis points, as widely expected, and promised further hikes in an effort to bring inflation back towards the central bank's 2% medium-term target.
"We see today's decision in favour of the larger step as a signal to markets that the central bank is serious about regaining its inflation-fighting credentials and that is it willing to accept costs in terms of lower growth to ensure price stability," Morgan Stanley economists wrote in a note.
"September was likely the best moment for the ECB to send this signal, given the expected slowdown ahead."
The pan-European STOXX 600 index ended a volatile session 0.5% higher, with banks rising 2.3% as the ECB abandoned the two-tier system for the remuneration of excess reserves.
"As rates have gone into positive territory the banks will make more money on lending," said Sumit Kendurkar, senior trader at Optiver in Amsterdam.
"Previously the ECB used to compensate them for lending at negative interest rates and now that is not going to happen but at the same time they will not be penalised for making more money on the positive rates, which has been taken very positively by investors."
The basic resources sector added 1.5%, attempting to recover from declines of more than 2% after disappointing China trade data on Wednesday added to worries about metals demand.
The STOXX 600 is down over 0.4% so far this week and is set to end its fourth week in the red as investors fret about soaring energy prices and a cost of living crisis in the wake of Russia's stoppage of gas flow to Europe through a major pipeline.
European retailers shed 1.6%, with Swedish retailer H&M and Zara-owner Inditex falling after U.S. peer American Eagle Outfitters Inc missed second-quarter profit estimates late on Wednesday.
Associated British Foods slid 7.6% after it warned of lower profit next year, as its Primark fashion business struggles with rising costs and surging inflation hits demand.
Atos dropped 15.1% to the bottom of STOXX 600 index, after Goldman Sachs downgraded the French IT consulting company to "sell", saying its weak financial profile and low visibility foretells a long way to recovery.
(Reporting by Shreyashi Sanyal, Sruthi Shankar, Shashwat Chauhan and Devik Jain in Bengaluru; Editing by Rashmi Aich, Krishna Chandra Eluri and Jane Merriman)