Banks spur rebound in European stocks as contagion fears recede

S&P says European banks can weather the market turmoil

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European banks rally over 3.8%

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Investors price in 25 bps rate hike by Fed

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Thyssenkrupp climbs on report of interest in steel division

March 21 (Reuters) - European shares rose over 1% on Tuesday, with banking stocks leading the recovery following a raft of measures to stabilise the sector, while investors hoped for less-aggressive moves by the U.S. Federal Reserve at its policy meeting this week.

The pan-European STOXX 600 climbed 1.3%, extending gains after the index sharply recouped intraday losses and closed the session up nearly 1% on Monday.

Lender heavy indexes of Spain and Italy added 2.5% each, outperforming the broader market.

The Fed's monetary policy meeting ends on Wednesday, with U.S. interest rate futures pricing suggesting that the central bank is likely to hike interest rates by a smaller 25 basis points in the aftermath of the recent banking crisis.

"It's a very tricky one to call because if they pause you might think that's good for risk assets, but then simultaneously if you give too many reasons for the pause then that could frighten the horses," said Chris Beauchamp, chief market analyst at IG Group.

"Fed could send the message that we're not done yet, but maybe we don't need to move quite as fast as we have done."

Europe's banking index jumped 3.8%, with shares in Swiss banks Credit Suisse rising 7.3% and UBS gaining 12.1%.

Banking stocks globally breathed a sigh of relief on Monday after UBS's state-backed takeover of the 167-year-old Credit Suisse and coordinated actions by central banks to boost liquidity raised hopes that a wider banking crisis was averted in the near-term.

Meanwhile, European regulators tried to stop the AT1 market rout on Monday saying owners of this type of debt would only suffer losses after shareholders have been wiped out - unlike what happened at Credit Suisse.

Investors were spooked by news that some $17 billion worth of AT1 Credit Suisse bonds will be written down to zero as part of the rescue merger but shareholders, who usually rank below bondholders in terms of who gets paid when a company collapses, will receive $3.23 billion.

Europe's banking index is down 12.7% so far in March - the weakest sectoral performer this month - as the collapse of U.S. mid-sized lenders Silicon Valley Bank and Signature Bank as well as troubles at Credit Suisse raised worries that a broader banking crisis was brewing.

Performance of European banks will be resilient albeit divergent as the economic reset kicks in, according to a note by S&P Global, with Credit Suisse being an outlier.

Shares of RWE rose 1.4% after Germany's biggest utility pledged a higher dividend and more investments to expand its core renewables business.

Thyssenkrupp climbed 4.5% after business daily Handelsblatt reported of interest in its steel business.