Financials lead FTSE rally on hopes of EU debt solution

A man walks past the London Stock Exchange in the City of London October 27, 2008.

LONDON (Reuters) - Financials drove gains on Britain's top share index on Thursday, as hopes a solution could be found to Europe's sovereign debt crisis boosted investor sentiment.

The benchmark index .FTSE closed up 46.07 points or 0.8 percent at 5,899.89, having endured a choppy session, trading in a 137 point range as nervous investors jostled positions awaiting an announcement from key debt talks in Brussels.

The bulls won the day as European Union officials seemed close to a deal to bail out debt-stricken Greece with the help of the private sector and with no new tax on banks.

Sources said the European Central Bank was willing to let Greece slip into temporary default as part of a crisis response.

"Potentially it's good news, but I think there are too many economic headwinds to make a definitive call that the worst is now behind us," Peter Dixon, an economist at Commerzbank, said.

"We've got to look at today's rally as simply a correction to some of the perhaps overly pessimistic sentiment that's crept in over the past week."

Banks .FTNMX8350 and insurers .SXIP, most exposed to European sovereign debt, rallied hard with Barclays (BARC.L) the top riser, up 7.8 percent.

UK-listed banks enjoyed their biggest one-day percentage gain since the start of 2011, but remain down over 8 percent in 2011.

Although the rally looked like an exaggerated knee-jerk reaction, valuations show shares in the FTSE are ripe for the picking, should uncertainty be removed over the European and U.S. debt situations.

"UK equity sector valuations are cheap, in fact the second-cheapest globally in P/E (price to earnings) terms, and yet they are the second-largest dividend yielder globally as well," said Mark Burgess, chief investment officer at British fund firm Threadneedle.

Thomson Reuters Datastream figures showed the FTSE 100 index .FTSE carrying a forward price-to-earnings ratio of 9.44 compared with a 10-year average of 14.15.

Beaten-down retailers such as Kingfisher (KGF.L), up 5.6 percent, enjoyed a strong rally after the group's update.

Drugmakers also added strength to blue chips, led by AstraZeneca (AZN.L), up 2 percent after falling in the previous session after its heart drug Brilinta gained approval from U.S. regulators, opening up the massive U.S. market to the company's biggest drug hope.

MINERS FALL

Relief that Europe was making progress on dealing with its debt problems, and hopes that it would avoid widespread contagion and plunge the region into a deep recession, was not enough to reverse losses in the mining sector .FTNMX1770.

The sector underperformed, suffering in tandem with easier copper prices after poor manufacturing data from top metals consumer China heightened worries over the growth outlook for the country.

Factory output in the world's largest consumer of commodities shrank in July for the first time in 12 months.

"We still forecast strong global GDP growth, at 3 percent to 4 percent in both 2011 and 2012. But we are again making more GDP forecast downgrades than upgrades," Willem Buiter, analyst at Citigroup, said.

Mixed economic data from the United States failed to dampen investor spirits as a rise in jobless claims was offset by a rebound in factory activity.

But concerns remain as U.S. lawmakers fight to forge a deal before an August 2 deadline to prevent the world's biggest economy defaulting on its debt.

On the downside, outsourcing group Capita (CPI.L) shed 1.6 percent as a bigger than expected 7 percent fall in organic revenue weighed on first-half results. Evolution Securities downgraded its rating to "neutral."

Peer Serco Group (SRP.L) dropped 1.1 percent.

Chip designer ARM Holdings (ARM.L) fell 1.6 percent as Nomura downgraded its rating on U.S. peer Intel Corp (INTC.O) to "reduce," a day after the top chipmaker cut its outlook for 2011 personal computer unit sales and elevated its capital expenditure.

(Additional reporting by Stephen Eisenhammer, Christopher Vellacott and Sinead Cruise; Editing by David Holmes)