By Patrizia Kokot

LONDON (Reuters) - European shares came off lows by midday on Tuesday as the banking sector reversed early losses, with UBS and BNP Paribas gaining more than 2 percent.

"The banks got hammered in early trade following the negative news from Lehman and Washington Mutual in the U.S. last night, but people also note that selling in the sector is overdone," Philippe Gijsels, senior equity strategist at Fortis Bank said.

But be cautioned that "problems in the financial sector remain".

Traders also pointed to a 191 billion euros (152 billion pounds) refinancing operation by the European Central Bank as well as a short-squeeze as a reason for the recovery in the banks.

"They are trying to push liquidity into the system and have done that a number of times when the market is selling quite aggressively," Gijsels said, adding that while this is good news for the sector, it only offers a short-term relief.

By 10.51 a.m. GMT (11.51 British time) the FTSEurofirst 300 index was down 0.5 percent at 1,273.58 points, having fallen earlier by as much as 1.3 percent to its lowest since April 1.

Banks could be facing more headwinds in future following remarks by European Central Bank President Jean-Claude Trichet last week that suggested the bank could raise rates further to battle inflation.

"Uncertainty about writedowns and capital hikes remain and hiking interest rates is very bad for the sector as it inverts the yield curve and means lower income in the short term," Gijsels added.