By Shashwat Chauhan and Pranav Kashyap

(Reuters) -European shares closed over 1% higher on Wednesday after an in-line inflation reading in the U.S. raised the chances of a second rate cut by the Federal Reserve this year.

The pan-European STOXX 600 jumped 1.3% to 515.02 points and snapped a three-day losing streak, and saw its best intraday percentage gain since Sept. 2024.

The rate-sensitive real-estate sector was the biggest boost to the benchmark index, surging 3.3%, while a 2% gain in financial stocks also provided support.

U.S. CPI rose at an annual rate of 2.9% in December, in line with expectations. Markets cheered the core inflation number that rose by 3.2%, however was below forecasts.

Traders now expect close to 40 basis points (bps) in rate cuts from the Fed this year, from around 30 bps before the inflation data. [MKTS/GLOB]

"Positive developments from U.S. inflation remaining under control can be seen across European markets today," said Lilian Chovin, head of asset allocation at UK private bank Coutts.

However, "we don't think the Fed needs to cut interest rates more than one time and equity markets can digest that, provided earnings continue to trend upwards and growth remains well supported."

British equities outperformed regional peers, with the UK's more domestically focussed midcap index closing 2.9% higher after data showed British inflation unexpectedly slowed to an annual rate of 2.5% in December, with the core measures of inflation falling more sharply.

The blue-chip FTSE 100 was up 1.2%. [.L]

European government bonds fell, providing tailwind for European equities. The yield on the region's benchmark 10-year bond fell to 2.53%, snapping a 10-day rising streak. [GVD/EUR]

Utilities, often traded as a bond proxy, added 1.8%.

In France, consumer prices rose 1.8% year-on-year in December, while Spain's EU-harmonised 12-month inflation rate rose to 2.8%.

A separate reading showed the German economy contracted for the second consecutive year in 2024.

Euro zone industrial production rose as expected in November but not enough to erase earlier losses. A poll showed the European Central Bank will extend back-to-back interest rate cuts at least until July in an effort to shield the weak euro zone economy.

"There is scope for positive surprises in Europe as the year progresses, although it's too early to say. On the corporate side, you're starting to see some inflection and positive numbers coming, so it could be the start of some improvement across the region," Chovin added.

European equities came under pressure earlier this month as bond yields surged tracking U.S. Treasuries.

Vistry surged 15.7% as the housebuilder kept its 2024 earnings forecast.

France's Bureau Veritas and Swiss testing and inspection company SGS said they were in merger talks. Bureau Veritas was up 2%, while SGS dropped 6.4%.

(Reporting by Shashwat Chauhan and Pranav Kashyap in Bengaluru; Editing by Janane Venkatraman, Saumyadeb Chakrabarty and Vijay Kishore)