* Spain's IBEX up 1.3 pct; STOXX 600 flat
* Catalonia makes no formal independence declaration
* Italian banks rise on EU proposal on soured loans
* Mondi drops after cutting FY guidance (Adds details, closing prices)
MILAN, Oct 11 (Reuters) - Spanish shares rebounded sharply in a flat European market on Wednesday on hopes that a big political crisis in the euro zone's fourth largest economy could de-escalate after Catalonia stopped short of declaring formal independence from Madrid.
While Spain's benchmark IBEX rose 1.3 percent, the pan-European STOXX 600 index ended flat and the euro zone blue chip index inched up 0.2 percent.
Spanish stocks have lagged their European peers this month with an 0.9 percent fall on worries of a possible break-up of the country following Catalonia's independence referendum on Oct. 1 that Madrid had deemed unconstitutional.
Concerns however eased after the region's separatist leader made only a symbolic declaration, triggering a response from the Spanish prime minister that could deepen the confrontation but also signals a possible way out of the crisis.
European equities have broadly brushed off the Spanish tensions while the fall on the IBEX remains limited. The Madrid index is still up more than 10 percent so far this year.
"For the wider European economy and probably even the wider Spanish economy I don't see huge risk at the moment and you see that in the muted market reaction," said Marcus Morris-Eyton, European equities portfolio manager at Allianz Global Investors.
Marcus Morris-Eyton's two Spanish holdings are Zara owner Inditex and information technology supplier Amadeus , two global companies which he said have little domestic Spanish exposure and are unlikely to be much affected by political developments.
Inditex added 1.3 percent and Amadeus rose 0.8 percent.
Banks Sabadell and Caixabank, which have moved their legal bases from Catalonia to other parts of Spain, rose 1.2 percent and 0.3 percent respectively after being severely hit this week by worries over the Crisis.
Sabadell and Caixa have the biggest exposure among top Spanish banks to private sector loans in Catalonia region, while Santander, and Unicaja, both up 0.6 percent, have the lowest.
Elsewhere Italian banking stocks rose 1.4 percent traders citing relief that new proposals by the EU Commission to strengthen the banking sector made no reference to stricter provisioning rules on the existing backlog of bad loans.
Top gainers were Banco BPM, UBI Banca, which rose 4.8 and 3.9 percent respectively.
Italian banks have been hit by a sell-off over the past week after the ECB Bank unveiled plans to require lenders to set aside more money on new soured debts. This has angered Italy, which fears this treatment could be extended to the current stock of non performing loans.
GEA Group was the biggest gainer on the STOXX, up 5.8 percent, after hedge fund Elliott revealed a stake in the in German food-processing machinery firm.
Some early results were also in focus, with shares in Mondi dropping 7.8 percent after the paper and packaging manufacturer cut its full-year guidance.
Estimates however point to European third-quarter earnings growing 5.3 percent from the same period last year, which would be an increase of 2.3 percent excluding the energy sector, according to Thomson Reuters I/B/E/S data.
Morris-Eyton said he was upbeat on earnings prospects for European companies, even though the effects of this summer's rapid surge in the euro needed to be monitored.
"We are generally pretty positive on European earnings and that's one of our major bull cased for Europe," he said.
(Reporting by Danilo Masoni and Kit Rees; Editing by Alison Williams)