Italian stocks lead Europe as budget deficit fears quelled

* Italy's FTSE MIB up 0.9 pct

* Norsk Hydro (LSE: NHY.L - news) sinks 11.9 pct on Brazil mine closure

* Altran (Paris: FR0000034639 - news) jumps 9.1 pct on Kepler upgrade to "buy"

* Grifols (Madrid: 13138883.MA - news) hit by UBS (LSE: 0QNR.L - news) downgrade to "sell"

* Swedbank (LSE: 0H6T.L - news) falls on Estonian data (Adds stocks, closing prices)

By Helen Reid

LONDON, Oct (Shenzhen: 000069.SZ - news) 3 (Reuters) - Italian stocks turned from a drag into a boost for European markets on Wednesday as signs the government would target a lower budget deficit quelled investors' fears of a damaging showdown with the European Commission.

Italy's FTSE MIB outperformed and closed up 0.9 percent while the leading euro zone stocks index and the pan-European STOXX 600 climbed 0.8 percent and 0.6 percent respectively.

Italian government bond yields fell back thanks to reports the government was targeting a lower budget deficit in 2020 and 2021.

European banks which were benefiting from the easing tensions in Italy gave up most of their gains in late afternoon trading.

The country's central bank said lenders doing business in Estonia, which has been at the center of a money-laundering scandal involving Danske Bank (LSE: 0NVC.L - news) , handled more than $1 trillion in cross-border flows between 2008 and 2017.

The European banking index lost about one percent on the news and ended the day only up 0.5 percent while Sweden's SEB (LSE: 0MGS.L - news) and Swedbank, which both have banking operations in Estonia, closed down 3.3 percent and 5.8 percent lower respectively.

Oslo-listed aluminum firm Norsk Hydro was the biggest individual faller, tumbling 11.9 percent after announcing it would shut all output from its Alunorte alumina refinery in Brazil.

"This is a very serious event for Norsk Hydro, potentially leading to severe losses," said a trader.

Grifols shares fell 5.8 percent after UBS analysts cut the stock to sell from neutral, saying competitive risks are rising.

"Fc Rn inhibitors, a new class of drug we expect to launch in 2021, threaten to replace up to 20 percent of Grifols sales," said analysts at the Swiss bank.

Tesco (Frankfurt: 852647 - news) shares fell 8.6 percent after Britain's biggest retailer reported first-half profits which missed analysts' forecasts.

"Good like-for-like (sales), but weak bottom line points to margin destruction," said a trader.

Shares (Berlin: DI6.BE - news) in French tech consultancy Altran jumped 9.1 percent, at the top of the STOXX after Kepler Cheuvreux analysts upgraded the stock to "buy" from "hold" with a price target of 10 euros.

Kepler analysts said they see no risk for liquidity, and that Altran's current share price values its global design and engineering company Aricent at roughly 0.

The stock, down 40 percent in the third quarter alone, is a popular short, amplifying any positive moves as short-sellers unwind their positions.

(Reporting by Helen Reid and Julien Ponthus Editing by Danilo Masoni and Andrew Heavens)