Europe's STOXX 600 at two-week closing high in lead-up to Fed rate decision

By Shubham Batra and Shashwat Chauhan

(Reuters) -Europe's STOXX 600 recorded its highest closing level in two-weeks on Tuesday, as global markets remained upbeat on the prospects of the U.S. Federal Reserve possibly opting for an outsized interest rate cut later this week.

The continent-wide STOXX 600 index closed 0.4% higher, with most local bourses also clocking gains.

Spain's benchmark jumped 1.1%, hitting its highest level in over nine years.

Retail led gains amongst major STOXX sectors with a 2.8% rise, boosted by a 11.2% jump Kingfisher after the B&Q and Castorama owner lifted the bottom end of its annual profit outlook.

Ryanair gained 6.1% after CEO Michael O'Leary told Reuters that the airline has seen better momentum in bookings since last month and less need to cut prices, adding that annual profit was likely to be slightly down on last year but remained "very strong".

The travel and leisure subindex, which houses most of Europe's airlines, advanced 2.2%.

Investors will be squarely focused on the Fed's decision on Wednesday, with markets now pricing in a 61% chance that the U.S. central bank could ease rates by 50 basis points, compared to a 34% chance seen a week prior, according to the CME FedWatch Tool.

"If the Fed doesn't initiate its easing cycle with 50-basis points surely a 25-basis point move will be enveloped by a dovish tone and offers the Fed the flexibility and gradualism in the event inflation remains even slightly elevated," said Quincy Krosby, chief global strategist at LPL Financial.

However, top brokerages such as Morgan Stanley and Deutsche Bank continue to expect the Fed to kick-off its policy easing cycle by a smaller 25-bps on Wednesday.

Back in Europe, the ZEW economic research institute said German investor morale darkened more than expected in September, with the sentiment index dropping 3.6 points from 19.2 points in August.

European defence firms such as Leonardo, Rheinmetall, BAE Systems and Kongsberg Gruppen languished at the bottom of the STOXX 600, with a gauge of aerospace and defence stocks sliding 1.8%.

Traders pointed to a media report that Ukraine's allies are starting to look at a ceasefire.

Among other headlining stocks, Barry Callebaut climbed 7.2% after Barclays raised the chocolate maker's rating to "overweight" from "underweight".

Playtech slid 5.2% after the British gambling technology firm agreed to sell its Italian unit Snaitech for 2.3 billion euros ($2.56 billion), including debt, to the world's largest betting company Flutter Entertainment.

London-listed shares Flutter closed up 3.2%.

(Reporting by Shubham Batra and Shashwat Chauhan in Bengaluru; Editing by Sherry Jacob-Phillips and Aurora Ellis)