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LONDON, Mar 17 (Reuters) The latest wave of takeover activity propelled European shares to fresh multi-year highs on Friday, while the dollar wallowed at a seven-week low against the euro on expectations U.S. rate rises may be drawing to a close.

Government bonds retained a firm tone, still benefiting from Thursday's soft U.S. inflation report which suggested the Federal Reserve might stop tightening monetary policy after just one or two more rate hikes.

U.S. stocks futures were flat, pointing to a steady start on Wall Street ahead of consumer sentiment data due at 1445 GMT (2015 IST). News from General Motors Corp. weighed on Dow Jones industrial average futures after the auto maker said its 2005 loss was $2 billion more than previously reported.

The FTSEurofirst 300 Index of European blue-chip stocks climbed 0.7 per cent to 1,377 points in morning trade, its highest since July 2001.

The index has jumped almost 8 per cent in 2006 -- already hitting levels that many strategists had forecast for the year-end as incessant merger and acquisition talk and action has swept through the market.

Companies, flush with record levels of cash from surging earnings growth and low interest rates, have been looking to spend to buy growth or ward off potential predators. Private equity interest has also boomed in recent months.

''The key thing is that equities simply are too cheap compared to the cost of money,'' said Rolf Elgeti, head of strategy at ABN AMRO.

''If you can use cash at low cost to buy other companies, to buy your own shares or spend on capex (capital expenditure), that is a tremendous opportunity for re-rating of shares.'' London's FTSE 100 rose above 6,000 points for the first time in five years.

INSURERS RALLY Insurers lead gains, with Zurich Financial adding 8 per cent after the Wall Street Journal reported the Swiss insurer was discussing a possible merger with U.S.-based St. Paul Travelers Cos.

European peers Aviva, Royal&Sun Alliance, Prudential and Aegon all rallied strongly on hopes of insurance sector consolidation.

UK retailer The Body Shop jumped 10 per cent after cosmetics giant L'Oreal said it would buy the specialist in ethically-sourced products for 652 million pounds in cash.

Shares in Vodafone also rose after it said it would return 6 billion pounds to shareholders from the sale of its Japanese mobile business to Softbank.

In Tokyo, the Nikkei average ended up 1.5 per cent at 16,339.7 points, with Softbank gaining before the announcement of the Vodafone deal and with property firms rebounding.

BONDS FIRMER Government bonds firmed, extending Thursday's rally.

Prices have fallen in recent weeks on expectations that central banks in the U.S., Europe and Japan are all moving to tighten monetary conditions but the tame U.S. consumer price data helped markets rein back expectations on how far U.S. rates will rise.

The yield on benchmark euro zone 10-year bunds was around 3.63 per cent, down from a peak above 3.7 per cent earlier this week.

''We had selling on Thursday in European bond markets and then a spike higher after U.S. data. That momentum has continued today, with a short squeeze occurring as traders exaggerated covering positions, pushing prices higher,'' said a trader in London.

Comparable U.S. 10-year notes yielded 4.65 per cent.

The dollar extended Thursday's tumble to a seven-week low versus the euro, trading around $1.2190 per euro.

''It's almost exclusively the rate outlook driving things in the sense that at the beginning of this week the market was 50/50 priced for a third rate hike this year with two priced in with certainty, but as things stand now even a second hike is looking questionable,'' said RBC Capital Markets senior currency strategist Adam Cole.

The dollar was down 0.6 per cent at 116.1 yen and could come under further pressure from any sign of weakness in the University of Michigan's preliminary consumer sentiment index for March, due at 1445 GMT (2015 IST).

Economists polled by Reuters expect a median reading of 88.0, compared with 86.7 in the final February report.

U.S. light crude dipped but held above $63 a barrel, while gold was little moved around $556 an ounce.

REUTERS SD ND1942