Reuters - European stocks climbed on Tuesday, extending their two-week rally, helped by M&A fever as well as robust French and U.S. factory data.

France's blue chip index CAC 40 hit a 5-1/2 year high, gaining 0.8 percent on the day, after data showed the manufacturing sector emerging from a long decline to grow even more strongly in March than initially estimated.

Overall, data showed growth in euro zone manufacturing eased slightly as expected, but the broad rise in output made the bloc's economic recovery look more entrenched, fuelling hopes of a long-awaited rebound in corporate profits.

Spanish stocks also rallied strongly, with the IBEX gaining 1.2 percent. A government source said on Tuesday Spain could raise its 2014 GDP growth forecast to between 1 percent and 1.5 percent as an economic recovery gathers pace.

In a similar picture from the other side of the Atlantic, the Institute for Supply Management (ISM) said its index of U.S. factory activity rose to 53.7 in March, up slightly from February's read of 53.2, accelerating for a second straight month as production rebounded.

The FTSEurofirst 300 index of top European shares ended 0.6 percent higher at 1,340.96 points, gaining ground for the sixth consecutive session. The benchmark index - which recorded a gain of 1.3 percent in the first quarter - has risen about 5 percent since mid-March.

The euro zone's blue-chip Euro STOXX 50 index rose 0.8 percent on Tuesday, to 3,186.34 points, hitting a level not seen since September 2008.

M&A FEVER

The European stock market's rally in the past few days has been fuelled in part by mounting expectations of new stimulus measures from the European Central Bank, cemented by lower-than-expected euro zone inflation data.

Last week, ECB policymaker Jens Weidmann said negative interest rates were an option, and that buying loans and other assets from banks to support the bloc was not out of the question. His comments surprised investors, given the monetary conservatism of the German central bank he heads.

"The comments made by Weidmann were very clear: the door is now open for quantitative easing in Europe, which is very good news for markets. This could be a game changer," Valquant strategist Eric Galiegue said.

"But beyond the support from the ECB, investors have plenty of reasons to be cautious at this stage. In Europe for instance, despite all the hype about a potential rebound in profits, earnings momentum remains negative, which is a red flag for me."

Despite the gains in stocks, Europe's earnings momentum - analysts' forecast upgrades minus downgrades as a percentage of the total - has been deteriorating since late January.

It has slipped from -2.9 percent two months ago to -4.6 percent, data from Thomson Reuters Datastream shows, highlighting an acceleration in analyst downgrades before the first-quarter earnings season. For a chart on earnings momentum, click: http://link.reuters.com/pag28v

However, M&A activity also boosted the mood on Tuesday, with Alstom rising 8.1 percent, after the French turbine and train maker said it would sell its heat exchange unit to Triton, a European private equity group.

Shares in Metso surged 19 percent after Scottish Weir Group approached the Finnish company over a possible $5 billion merger.

"(These deals) are encouraging as they indicate confidence in the markets that corporates are willing to put their hands in their pockets to undertake M&A," said Neil Wilkinson, European equities fund manager at Royal London Asset Management.

Investors also welcomed reports that global mining company BHP Billiton was weighing options to simplify its assets including a possible spin-off of some businesses, sending its shares up 2 percent.