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* Optimism around ECB stress tests is short-lived
* German Ifo index falls to lowest in almost 2 years
* Wall Street set to open down ahead of data
* Italy's Monte Paschi drags down bank share index
* Brazil markets suffer losses after Rousseff election win
By John Geddie
LONDON, Oct 27 (Reuters) - European shares and the euro gaveup early gains as weakening German business morale dousedinvestor enthusiasm over slightly better-than-expected bankstress test results.
Most government bond yields stayed lower on the day,however, after the business climate index in the bloc's largesteconomy fell to its lowest level in almost two years, raisingthe prospect of further ECB monetary stimulus.
Wall Street looked set to open lower before data on U.Sservices sector growth and home sales.
Around one in five of the Europe's top lenders failed thetests at the end of last year and many have since repaired theirfinances, results released on Sunday showed.
"The success of the exercise has been that it has forcedbanks to raise capital ahead of it, and we can now be moreconfident of their resilience to future crises," said AberdeenAsset Management's co-head of credit research Neil Williamson.
But while the stress tests beat market expectations, thelong-term attractiveness of the sector has been damaged byrevelations of extra non-performing loans and hidden losses thatwill dent future profits.
The bloc's banking index initially rose 1 pct beforereversing gains as shares in Italy's Monte dei Paschi -- one ofthe big losers from the tests -- plunged 20 percent.
The index of top European shares also dipped 0.3pct, erasing early gains.
The euro initially proved fairly resilient to the poor databut slowly eased back to be flat on the day at just below $1.27.
Yields on Italian 10-year government bonds -- the largestmarket in the euro zone's southern periphery -- were 1 basispoint lower even though nine Italian banks fell short in thetests, with Monte dei Paschi and Banca Carige still needing toraise funds.
Euro zone "banks face a significant challenge as the sectorremains chronically unprofitable and must address their 879billion euro ($1.1 trillion) exposure to non-performing loans asthis will tie up significant amounts of capital," accountancyfirm KPMG noted.
Spanish yields -- another peripheral bellwether -- were thebest performers, some 5 bps lower on the day, while Germanequivalents were 3 bps lower.
"There's some relief this morning that there were no Spanishbanks in the test that failed. As for Italy -- that was alreadypriced in," said Emile Cardon, market economist at Rabobank.
Attention now turns to the ECB's announcement of its coveredbond purchases, the first in a new bond-buying programmeintended to help unclog credit channels and stimulate lending tothe real economy.
If the figures due at 1430 GMT disappoint, it will be seento support calls for a broadening of the programme to includecorporate or even sovereign bonds.
In emerging markets, Brazil's opened with big losses afterincumbent President Dilma Rousseff won the election, beating herpro-market opponent by a narrow percent majority.
Brazilian stocks plunged 5 percent to seven-month lows, with state-run oil company Petrobras down 13 percent,and banks' shares falling 4-6 percent. Brazilian 5-year creditdefault swaps rose 10 bps and bond yields rose too.
Russian stocks were up around 1 percent afterStandard & Poor's kept the sovereign credit rating steady at onenotch above junk, despite fears of a downgrade.
The rouble fell to record lows against the dollar after a 35kopeck widening in the rouble's trading band and central bankinterventions on Friday.
Among commodities, Brent crude extended losses, falling over1 percent to $85.56 a barrel, after Goldman Sachs cutits price forecasts. Crude continued on a months-long rout assigns of rising global supply threatened deeper price losses.
Iraq increased its oil supply in October and Libya's outputremains 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; Editingby Catherine Evans/Ruth Pitchford)