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Steel boost: Lakshmi N Mittal, chairman of the board of directors and CEO of ArcelorMittal

EUROPEAN shares closed at a two-month high on Tuesday (July 3), led by gains in ArcelorMittal and other commodity stocks and supported by expectations that policymakers will take further steps to tackle the region's debt crisis.

The FTSEurofirst 300 index rose 1 per cent to 1,046.11 points, its highest closing level since it ended at 1,048.07 points on May 1.

The Euro STOXX 50 index rose 1.2 per cent to 2,320.43 points, marking its highest close since April 27.

Markets extended a rally begun last Friday (June 29), when European Union leaders cleared the euro zone's bailout fund to inject cash directly into struggling banks.

"The fact that the banks could be recapitalised directly has given the markets the direction they were looking for," said Securequity sales trader Jawaid Afsar.

"But I suspect that the upside from here is limited to another 100 points. We have to be careful, there are still fundamental problems out there and we would look to take a quick exit on any signs of weakness."

Traders said markets could also gain further ahead of an expected European Central Bank interest rate cut on Thursday (July 5).

Steelmaker ArcelorMittal gained 5.6 per cent, boosted by an upgrade from broker Kepler, which raised its recommendation to "hold" from "reduce".

Commodity stocks have rallied since last Friday's EU summit, on hopes that moves to counter Europe's debt crisis could help the overall global economy, thereby strengthening demand for their products.

Morgan Stanley strategists raised their position on European equities to "neutral" from "underweight", and Didier Duret - chief investment officer at ABN AMRO's private banking arm - said he too had turned "neutral" on European equities.

"The money will flow into the safest European equity markets, such as Germany, Switzerland and Austria," he said.

But Tiverton Trading portfolio manager Luc Bocahut said the European equity rally could end abruptly, due to the weakness in the broader economy and potential snags to the new measures to fight the crisis.

On Tuesday, the French Prime Minister cut the country's economic growth forecasts for 2012 and 2013, while on Monday (July 2) the Finnish government told parliament that Helsinki and its Dutch allies would block the euro zone's permanent bailout fund from buying government bonds in secondary markets.

"The economies of the world are slowing down, which is adding to deflationary pressures. This rally could prove to be more dangerous and short-lived than the usual short-covering rally, creating a significant selling opportunity," Bocahut said.

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