European shares closed at their highest level in five-and-a-half years, buoyed by a flurry of takeover activity and supported by oil stocks as crude crept back towards $63 a barrel.

BAE Systems rallied after British prosecutors dropped an investigation into past defence deals with Saudi Arabia, while Portugal's Millenium bcp jumped as investors bet it could be vulnerable to a takeover.

"The markets are in relatively good shape. We're seeing a little bit of a year-end rally," said Thomas Muehlberger, fund manager at Bayern Invest in Munich.

"Everyone is turning around his portfolio and a lot of people were thinking it would be better to have a little bit more exposure to equities. There's a lot of money looking for returns."

The FTSEurofirst 300 index of top European shares climbed for a 10th consecutive session, ending up 0.6 per cent at 1,489.1 points, its highest close since May 2001.

The index rose 2.7 per cent for the week and notched up its biggest weekly points gain in almost five months.

The European index is up almost 17 per cent since the start of the year after a burst of takeover activity and a recent string of economic data showing a resilient US economy helped European equity markets rebound from a seven-week low on December 1.

"Equities have outperformed fixed-income securities, and within equities Europe has outperformed other regions," said Goldman Sachs strategists in a report.

"We forecast 11 per cent total returns for European equities in 2007."

Equities held their ground after data showed US consumer prices held steady in November, confounding expectations of a small rise, and raising expectations the Federal Reserve may soon be able start cutting interest rates.

Oil stocks gained as crude oil headed back towards $63 a barrel after Opec agreed to cut supply for the second time in two months. BP rose 0.5 per cent, Royal Dutch Shell added 0.6 per cent and BG rose 1.5 per cent.

Construction stocks were also stronger, with Bouygues up 2.6 per cent and Eiffage 2.5 per cent higher.