With surprising audacity, European markets Thursday brushed off the NATO alliance's bombing of Yugoslavia and showed strong recoveries after Wednesday's panicky retreats.

The strong rebounds reflect the view that the allied campaign will force an early compromise from Yugoslav President

Slobodan Milosevic

. As a result, the attack will not provoke a wider Balkan conflict, Russian military involvement will be avoided and deep divisions between European states will not occur, according to a range of pundits.

"NATO is probably hoping to get this over in a week," says Nick Douch, European strategist at

Barclays Capital

in London. "I think the market reaction was too negative Wednesday."

Turkey's

Istanbul Stock Exchange 100 Index

rebounded 4.63% Thursday after dropping 2.2% Wednesday. Poland's

WIG Index

climbed back 2.5% today after diving more than 5% Wednesday. Italy's

Mibtel

Thursday made back all of Wednesday's losses and Germany's

DAX

, after a 2.74% fall on Wednesday, made a partial recovery, climbing 1.74%.

The

Athens Stock Exchange

was closed Thursday for a public holiday after plunging nearly 5% Wednesday. Even Russia's

RTS Index

made back most of Wednesday's 5% drop, although the ruble continued to lose ground to close around 27 to the dollar Thursday.

The dollar/euro rate was barely changed at $1.08 to the euro at 5:30 p.m. EST Thursday after a slight drop Wednesday.

A Feeble Response to the Bombardment

Despite Milosevic's defiant tone in a televised speech Wednesday night, Yugoslavia's response to the allies' Wednesday attack, which reportedly included over 100 cruise missiles, has so far been feeble. NATO, which has not reported casualties or the loss of any planes, claims that Yugoslav opposition was light. Thursday, NATO reported that it had destroyed three enemy fighters and hit 40 targets.

Milosevic also faces the growing possibility that pro-Western Montenegro will divorce itself from the Federal Republic of Yugoslavia and isolate Milosevic's Serbia, which includes the province of Kosovo. NATO, which has launched a second round of attacks, is trying to force Serbia to give much more autonomy to Kosovo, where ethnic Albanians far outnumber the Slavic Serbs.

"We've seen before that Milosevic is a brinksman who exacts as much as he can before backing down," says Douch, who argues that the 1995 NATO air attacks on Bosnian Serbs helped force Milosevic to peace talks in Dayton, Ohio, which eventually led to a settlement in Bosnia. However, Milosevic's desire to reach a deal then was also due to territorial advances by Croatia.

According to a

BBC

report Wednesday, the Serbian newspaper

Politika

, essentially a government mouthpiece, hinted that Milosevic may accept a peacekeeping force in Kosovo under certain circumstances. The newspaper said in its Wednesday edition that if the Kosovo Albanians agreed to a constitutional solution acceptable to Serbia, the country "would be prepared to negotiate on the size and makeup of a foreign presence in Kosovo." Of course, allied bombing may have since hardened the Serbs' stance.

Fears that the bombing will spark a Balkan war are also being downplayed. Some argue that Greece, a NATO member, could attack Macedonia and Albania if these countries joined forces militarily to help Kosovo. Turkey, also in NATO, would then enter on the side of Macedonia and Albania, some say.

However, such an outbreak is unlikely, as NATO forces are stationed in Macedonia. "I'd be surprised if the current hostilities in the Balkans would lead Greece and Turkey into a direct conflict," says Daniel Pipes, head of the

Middle East Forum

, a think tank. "After all, there's been fighting there for most of this decade and the NATO aerial bombardment is not a major transformation."

"You have to remember that Iraq is more important to Turkey than

is Yugoslavia," adds Atif Cezairli, Istanbul-based head of research at

ING Barings

.

Italian PM's Comments Spark Some Concern

Another source of concern is that the NATO strikes could deeply divide

European Union

member countries and hold up the region's integration plans, particularly the single currency, which has had a weak start since its launch at the beginning of this year.

Such worries seemed justified after Italian Prime Minister

Massimo D'Alema

, at an EU summit in Berlin Thursday, said that the allies should soon think about stopping the bombing and returning to talks with Milosevic. His conciliatory stance is at odds with those of other NATO members.

D'Alema's desire to negotiate is partly an attempt to appease his coalition partners, the

Party of Italian Communists

, which threatened to leave the center-left government over the air strikes. Italy is also the base for many of NATO's planes.

However, D'Alema is unlikely to go as far as ending NATO use of Italian air bases, says Patrick McCarthy, a professor at the Bologna, Italy-based section of the School of Advanced International Studies (a part of

Johns Hopkins University

).

"The fighting would have to get pretty bad before D'Alema pulled Italy out of the alliance," says McCarthy. "D'Alema is an ex-communist who doesn't want to do anything that would ruin his attempts to legitimize his party," the

Democratic Party of the Left

.

Instead, D'Alema, says McCarthy, "wants to stay in the alliance to use his influence to try and discontinue the bombing and stop NATO from deploying ground troops."

The Russian Question

U.S. relations with Russia also seem to be cooling after President

Boris Yeltsin

and Prime Minister

Yevgeny Primakov

robustly attacked NATO's strikes. Protesting the hardening U.S. stance toward Yugoslavia, Primakov earlier this week canceled a visit to Washington at the last minute, ordering that his plane turn around over the Atlantic and fly back to Moscow.

However,

Treasury

Secretary

Robert Rubin

was reported as saying Thursday that he didn't think Primakov's cancellation would affect negotiations with the

International Monetary Fund

. IMF chief

Michel Camdessus

is scheduled to meet Primakov this Saturday in Moscow, where they will try to hammer out a deal that will let the fund make more loans to Russia.