Italy's economy rose 0.4 percent in the first quarter thanks to firm domestic demand, the statistics bureau said, sharply raising a preliminary estimate and improving prospects for the year.

The pan-European STOXX 600 <.STOXX> index was up 0.3 percent, while Italy's FTSE MIB <.FTMIB> rose 1.1 percent as it extended gains after the GDP data release.

The data prompted renewed interest in Italian stocks after a selloff earlier this week when investors were rattled by worries over early autumn elections in the euro zone country and the rescue of two ailing regional banks.

"The data is better than expected. It's good news," said Prometeia economist Stefania Tomasini. "The recovery is helped by an acceleration of household consumption while the slowdown to investment was a disappointment."

Italian banks <.FTIT8300> rose 1.2 percent, having been among the hardest hit by this week's drop. UniCredit (>> UniCredit SpA) rose 0.6 percent after HSBC raised its target on the stock on optimism about the heavyweight lender's restructuring plan.

"The first quarter results were the first chance we got to take a glimpse at execution with management able to tick all boxes ... At the same time, core revenues continue to perform well," HSBC analyst Jason Kepaptsoglou said in a note.

Elsewhere in the broader European banking sector, Spain's Banco Popular (>> Banco Popular Espanol SA) plunged 16 percent after a top European watchdog warned European Union officials that the Spanish bank may need to be wound down if it fails to find a buyer.

Among the larger banks, Deutsche Bank (>> Deutsche Bank AG) fell 0.5 percent while Credit Agricole (>> Crédit Agricole) was up slightly. Overnight, U.S. bellwethers JPMorgan and Bank of America both warned of weak trading revenues in the second quarter which pulled banking stocks sharply lower on Wall Street.

In London, strength in blue chip exporters helped the benchmark FTSE 100 <.FTSE> index inch back towards an all-time high.

Inmarsat (>> Inmarsat Plc) gained 4.8 percent and France's SES (>> SES) also rose sharply on speculation they could be takeover targets following reports that Softbank would let its planned $14 billion (£10.8 billion) merger between satellite startup OneWeb and Intelsat collapse.

Akzo Nobel  (>> Akzo Nobel) fell 1.2 percent after U.S. rival PPG Industries (>> PPG Industries, Inc.) said it would not launch a formal bid for Akzo after repeated informal offers were rejected.

BT Group (>> BT Group plc) fell 0.5 percent after a downgrade by Morgan Stanley which raised concerns over the company's cash flows.

Online car retailer Auto Trader (>> Auto Trader Group PLC) hit a record high after Barclays upgraded the stock to "overweight." Its shares were up 4.7 percent.

(Reporting by Danilo Masoni and Elisa Anzolin Additional reporting by Vikram Subhedar; Editing by Susan Fenton)

By Danilo Masoni