LONDON (Reuters) - Spain's and Italy's stock markets fell on Monday as fears they will struggle to enact reforms needed for growth returned, but a report that Germany may agree to combine the euro zone's two bailout funds temporarily lifted the two countries' bonds.
European shares were higher overall following a strong German economic survey, while U.S. stock futures pointed to a higher opening on Wall St. The FTSEurofirst 300 index .FTEU3 was up 0.4 percent at 1,085, recovering after early declines, while the German DAX .GDAXI gained 0.65 percent after the survey's release.
The Ifo index showed German business morale rose in March to 109.8 from last month's 109.6, bettering the consensus forecast for no change and confounding some expectations of a weaker figure after disappointing economic surveys last week.
Although the euro zone debt crisis has eased, fears that Italy and Spain may struggle to cut their debt burdens and revive growth have resurfaced. Both countries are seen as being too big for the euro zone to bail out.
The Ifo has now risen for five consecutive months, showing Europe's largest economy continues to outpace other euro zone states.
Jennifer McKeown at Capital Economics said the survey showed the German economy remains resilient.
"Note, though, that this month's rise was the smallest in the past five months, suggesting that maybe the run of optimism regarding the German economy is coming to an end... While exports are faring relatively well, cautious German consumers are still not really spending despite the resilience of the labor market," McKeown said.
"In all, while Germany will continue to outperform other countries in the euro zone, any recovery will not be strong enough to pull them out of recession. We suspect that the economy will do little more than stagnate this year."
The euro rose to above $1.3260 against the dollar after the Ifo release, but worries about the bloc's peripheral economies prompted selling into the bounce and it quickly gave up its gains to trade at $1.3200, down 0.55 percent on the day.
Spain's IBEX .IBEX share index fell 1.6 percent, hitting a two-and-a-half week low, led by banks BBVA (BBVA.MC) and Banco Santander (SAN.MC), after the governing People's Party failed to secure an outright majority in elections in Andalucia. The result was a setback for Prime Minister Mariano Rajoy as he seeks to impose further cuts in public spending.
"The market is more negative about Spain. It has a large deficit and the election in Andalucia is causing uncertainty," said Andrea Williams, who manages $2.1 billion for Royal London Asset Management.
"Spain has got to make severe adjustments and deleverage and banks are being hit as there is no loan growth in the country."
Italy's FTSE MIB .FTMIB also fell on worries that problems in Spain could spread to Italy after Italian Prime Minister Mario Monti said on Saturday he was concerned about contagion.
The Euro STOXX 50 volatility index .V2TX, a key gauge of European investor fear, rose 5.9 percent, showing lower investor appetite for risk. MSCI's main world stock index .MIWD00000PUS was flat.
Bund futures were seven ticks up at 137.59, while German 10-year yields were little changed at 1.872 percent. Yields on 10-year Bunds broke below 2 percent last week as recession fears boosted demand for low-risk government debt.
Italian and Spanish bonds rose, outperforming low-risk German debt, after a news magazine reported Germany may be ready to do a deal to bolster the euro zone's capacity to support troubled sovereign debtors by combining the resources of its two bailout funds for a limited time.
European Union finance ministers are expected to discuss on Friday how to create a firewall big enough to prevent Italy and Spain being sucked back into the region's debt crisis.
"If the Germans are prepared to increase the firewall, that clearly is some good news for the periphery after the selloff we saw last week so we're seeing some temporary support of Italy and Spain on the back of that," said RIA Capital Markets strategist Nick Stamenkovic.
"But until we see signs that the fiscal position is taking a turn for the better in Spain, and Italian labour reforms are pushed through in parliament, which are crucial to improving the medium term growth prospects, it's difficult to see a sustained decline in yield spreads over Bunds in the near term."
Spanish 10-year yields were 6 basis points down on the day at 5.33 percent, but were seen vulnerable to a selloff after the regional poll result.
Italy's 10-year yields were 5 bps lower at 5.01 percent and are expected to remain around that level before auctions on Thursday of up to 7.5 billion euros of bonds.
Italian yields broke above 5 percent last week on worries about political instability as Monti's government battles to push through labour reforms needed to spur growth.
Oil prices were steady at around $125 per barrel, pausing after a rally of around 1.5 percent the previous session.
Reporting by London markets team; Editing by John Stonestreet and Andrew Osborn