By Simon Falush

LONDON (Reuters) - The top share index closed 2.5 percent higher on Friday, led by rebounding banks boosted by improving global sentiment and M&A activity in the troubled sector.

The FTSE 100 .FTSE was up 135.4 points at 5,506.6. The benchmark gained 0.6 percent for the week but is still down 15 percent for the year.

Banks were the biggest gainers, rebounding after recent losses as Barclays (BARC.L: Quote, Profile, Research), Royal Bank of Scotland (RBS.L: Quote, Profile, Research), Lloyds TSB (LLOY.L: Quote, Profile, Research), HBOS HBOS.L, HSBC (HSBA.L: Quote, Profile, Research) and Standard Chartered (STAN.L: Quote, Profile, Research) gained between 2.6 and 7 percent.

Banks were aided by generally improved sentiment after Federal Reserve Chairman Ben Bernanke said the recent decline in commodity prices and the stabilisation of the dollar were encouraging.

Financials were also supported by news that State-run Korea Development Bank said Lehman Brothers LEH.N was one of its options for acquisitions, reviving expectations that the U.S. investment bank may still bring in a large investor.

Data showed the UK economy unexpectedly ground to a halt in the second quarter pushing trade-weighted sterling to its lowest in 11-1/2 years =GBP and briefly knocking a few points off the FTSE 100.

But the index soon resumed an upward trajectory as optimism on global growth outweighed concerns on the domestic economy.

"Remarkably given the bad news that's out there, the index is up as the (Lehman) takeover story has driven bank stocks higher which has pushed up the index," said Peter Dixon, UK economist at Commerzbank. "But you have to ask is it sustainable? I don't think so."