M&A, Spain turmoil liven up Europe stocks

MILAN (Reuters) - Deal-making and political turmoil in Spain livened up a flat session in Europe' stock markets on Wednesday as investors awaited pointers from the Federal Reserve on the U.S. interest rate outlook.

While caution dominated the broader market, Spanish stocks were hit hard after police arrested Catalan government officials in a bid to halt a banned referendum on independence.

"Market are starting to realize how deep the crisis is (in Spain)," said Jesus Castillo, an economist covering Southern Europe for French bank Natixis.

Madrid's blue chip index <.ibex>, the best performer among major European benchmarks so far this year, fell 0.8 percent, underperforming the pan-European STOXX 600 <.stoxx> which ended flat.

Among the biggest fallers in Madrid were Catalonia-headquartered banks Banco Sabadell and Caixabank , which fell 3.8 and 1.9 percent respectively.

On the M&A front, Thyssenkrupp rose more than 2 percent after it and India's Tata Steel agreed to merge their European steel operations to create the continent's No.2 steelmaker.

Also in the spotlight was Fortum after the Finnish power company said it was in talks to buy German utility E.ON's remaining stake in Uniper , the power stations and trading business it spun off last year.

The news lifted shares in the three companies, which ended up between 2.7 percent and 5.9 percent.

In the banking sector, Commerzbank rallied 2.4 percent after a Reuters report said Italy's UniCredit had recently told Berlin it was interested in eventually merging with the state-backed German bank.

UniCredit fell more than 2 percent as the possible deal was seen as another strategy shift for Italian lender.

"While the higher exposure to Germany (and lower to Italy) could be considered appealing by some investors, the contradictory strategy would likely weaken the stock," a Societe Generale analyst said in a note to clients.

In the construction sector, German builder Hoctief fell 7 percent after media reports said it could launch a takeover for Spanish toll road operator Abertis on behalf of its parent ACS

Britain's Kingfisher rose 5.6 percent after the home improvement retailer reported a better-than-expected profit for the first half.

By sector, banks <.sx7p> were in particular focus, ending down 0.4 percent as investors awaited the result of the Fed meeting.

Banks, which have outperformed the broader market so far this year, generally benefit from higher interest rates.

"An interest rate rise would definitely be good for global banks ... there is over a 50 percent chance of one more rate rise in the U.S. before December," Rachel Winter, senior investment manager at Killik & Co, said.

(Reporting by Danilo Masoni; additional reporting by Kit Rees; editing by John Stonestreet)