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Bank tests comfort investors but growth worries persist

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[October 27, 2014]  By John Geddie

LONDON (Reuters) - Low-rated government bond yields dropped and the euro edged tentatively higher on Monday as the results of euro zone bank health checks spared investors immediate pain.

Early exuberance in European stock markets was subdued, however, by a survey showing weakening German business morale.

Fewer than one in five of the bloc's top lenders failed the tests at the end of last year and many have since repaired their finances, results released on Sunday showed.

"The success of the exercise has been that it has forced banks to raise capital ahead of it, and we can now be more confident of their resilience to future crises," said Aberdeen Asset Management's co-head of credit research Neil Williamson.

But while the stress tests beat market expectations, the long-term attractiveness of the sector has been damaged by revelations of extra non-performing loans and hidden losses that will dent future profits.

The bloc's banking index initially rose 1 pct <.SX7E> before reversing gains as shares in Italy's Monte dei Paschi -- one of the big losers from the tests -- plunged 17 percent. <BMPS.MI>

The index of top European shares <.FTEU3> dipped 0.5 pct, reversing early gains, after the Ifo business climate index slipped to its lowest level in nearly two years pointing to a bumpy fourth quarter for Europe's largest economy.

The euro proved fairly resilient to the poor data and was a touch stronger on the day at around $1.27 [FRX/].

Yields on Italian 10-year government bonds -- the largest market in the euro zone's southern periphery -- were 2 basis points lower even though nine Italian banks fell short in the tests, with Monte dei Paschi and Banca Carige still needing to raise funds.

Euro zone "banks face a significant challenge as the sector remains chronically unprofitable and must address their 879 billion euro ($1.1 trillion) exposure to non-performing loans as this will tie up significant amounts of capital," accountancy firm KPMG noted.

Spanish yields -- another peripheral bellwether -- were 4 bps lower, as were Portuguese and Irish equivalents.

"There's some relief this morning that there were no Spanish banks in the test that failed. As for Italy -- that was already priced in," said Emile Cardon, market economist at Rabobank.

Earlier, Asian equities closed slightly higher buoyed by the ECB's test results and U.S. and British data on Friday which helped allay fears that the global economy was heading towards another recession.

The MSCI's broadest index of Asia-Pacific shares outside Japan closed up 0.1 percent.

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Data on Friday showed new U.S. home sales rose to a six-year high, while Britain's economy expanded 0.7 percent in the third quarter, still on track to outpace other advanced economies.

Brazilian markets looked set to open with big losses after incumbent President Dilma Rousseff won the election, beating her pro-market opponent by a narrow percent majority.

Next Funds' Tokyo-listed Ibovespa exchange traded fund, which tracks Brazil's equity index, dropped almost 7 percent to seven month lows. The London-listed Brazil MSCI i-shares ETF fell 9.7 percent to seven month lows, albeit in thin turnover.

Russian stocks were up around 1 pct after Standard & Poor's kept the sovereign credit rating steady at one notch above junk, despite fears of a downgrade.

The rouble fell to record lows against the dollar after a 35 kopeck widening in the ruble's trading band and central bank interventions on Friday.

Among commodities, Brent crude extended losses, falling 56 cents to $85.56 a barrel, after Goldman Sachs cut its price forecasts. Crude continued on a months-long rout as signs of rising global supply threatened deeper price losses.

Iraq increased its oil supply in October and Libya's output remains high, despite instability in both countries.

Gold was a touch higher at $1,231.06 an ounce.

(Additional reporting by Sujata Rao and Marius Zaharia; Editing by Catherine Evans/Ruth Pitchford)

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