European shares post biggest daily gain in three years

(Updates with closing prices)

* FTSEurofirst 300 up 2.8 pct after strong U.S. data

* Euro zone banks rally on ECB stimulus speculation

* Car (HKSE: 0699.HK - news) makers rally after positive sales figures

* European equity funds suffer record weekly outflows -Lipper

By Francesco Canepa

LONDON, Oct 17 (Reuters) - A key pan-European equity index posted its biggest daily gain in three years on Friday as stronger U.S. data fuelled a rebound from recent sharp losses and speculation about monetary easing stabilised lower-rated euro zone bonds.

The FTSEurofirst 300 index rose 2.8 percent to 1,280.17 points in its biggest daily bounce since Nov. 30, 2011. Trading volume on the index was at its highest since June 15, 2012, also boosted by a monthly option expiry.

The index extended gains after a widely followed survey showed U.S. consumer sentiment rose in October to the highest in more than seven years and strong earnings from U.S. industrial groups General Electric and Honeywell.

It had fallen nearly 12 percent over the previous month, as weak euro zone economic data raised the spectre of a new recession there just as the U.S. Federal Reserve winds down its asset purchases and with no such programme in Europe.

"Valuations have improved after the sell-off," said Fadi Zaher, who helps to manage assets worth 7.5 billion euros ($9.5 billion) at Kleinwort Benson.

"However, on a relative basis, European equities are not attractive for the risk that they represent (and) have to underperform the U.S. by 10 percent to become attractive from current levels."

Euro zone banks gained 4.2 percent, mirroring gains in Italian, Spanish, Portuguese and Greek bonds as traders speculated about more aggressive asset purchases from the European Central Bank.

Greek banks rallied 6.4 percent after Prime Minister Antonis Samaras said his government was in talks with lenders over the country's post-bailout period and dismissed the prospect of new elections. They had shed some 16 percent over the previous three days, leading the Athens bourse lower.

Car makers surged 3.5 percent, with France's PSA Peugeot Citroen up 7 percent, after data showed car sales in Europe rose 6.1 percent in September, the 13th straight month of growth in sales.

On the downside, a warning from Rolls-Royce that it would not return to growth next year sent shares in the British engineering group down 11.5 percent.

Technology firm Gemalto (Other OTC: GTOFF - news) tumbled 11 percent after Apple (NasdaqGS: AAPL - news) unveiled a new SIM card that will be installed in its iPads, sparking worries over the future of Gemalto's own smart chips for mobile phones, traders said.

MARKET OVERSHOT

The month-long sell-off in European stocks prompted U.S.-based investors to slash their exposure to Europe in the seven days to Oct. 15, according to data from Thomson Reuters Lipper.

A Lipper poll of 109 U.S.-domiciled funds invested in European stocks, which include exchange-traded funds' (ETFs) holdings, shows net outflows of $1.3 billion, the biggest weekly redemptions since Lipper started to monitor the data in 1992.

"We think sentiment and fund flow have exaggerated the recent sell-off, and although the fundamentals may have worsened a bit, the equity market has overshot," Barclays Capital analysts said.

"Economic growth expectations have come down a bit, and incoming data have disappointed, but the stock market appears to us to have overreacted."

In this context, many fund managers were holding on to their equities or even increasing their equity positions, seeing value in shares after the recent slide in prices.

"I think markets will bounce back," Cazenove Capital Management's chief investment officer, Richard Jeffrey, said. "I don't think anything really fundamentally has changed."

(1 US dollar = 0.7833 euro) (Editing by Catherine Evans)