Europe stocks drop as rate rises rattle investors

European shares tumbled yesterday, rattled by the Bank of England's surprise interest rate rise and hawkish comments from the European Central Bank, after it upped interest rates as expected.

Banking and property stocks fell as investors worried that higher interest rates would impact earnings, while oil shares weighed as crude slipped below $75 a barrel. Unilever slid and Rio Tinto fell after posting results.

"The UK rate rise caught the market by surprise, it didn't expect this move," said Andreas Gartner, fund manager at SEB.

"The fundamental news from companies is very good but the macro side is still a problem, as is the Middle East. The market will move sideways until the macro side lightens up a little bit.

The pan-European FTSEurofirst 300 index closed down 0.9 per cent at 1,329.8, scraping off its 1,324.9 intra-day low.

The FTSE 100 index underperformed, dropping 1.6 per cent after the UK central bank increased rates by 25 basis points to 4.75 per cent, citing firm growth and expectations inflation would stay above its target.

"The timing of the hike has clearly destabilised markets," said Paul Niven, head of asset allocation at F&C Asset Management, in a note.

"However, with the tightening cycle in the US nearing its peak, and the medium-term outlook for the UK and global economy pointing towards slower rates of growth, one should exercise caution about the probability of further hikes."

Around Europe, Paris's CAC 40 index lost 0.9 per cent while Frankfurt's DAX fell 0.7 per cent after the ECB raised rates by 25 basis points to three per cent, its fourth increase since December.

President Jean-Claude Trichet said the bank would watch inflation risks very carefully and said monetary policy was still accommodative, raising expectations of an October rise.

Oil stocks weighed on the market, with BP down 2.2 per cent and Royal Dutch Shell losing two per cent.

France's Total dropped 0.8 per cent as its second- quarter profit came in line with estimates and it tipped higher production in 2007.

Financial, property and construction stocks languished as investors worried about the impact of higher rates on earnings, with HBOS down three per cent and British Land sliding 3.9 per cent.

Germany's Hochtief was down 2.3 per cent. Barclays reported a better-than-expected rise in half-year profits but it shares fell 1.4 per cent, partly due to concern its UK mortgage business continues to struggle and bad debts will remain high in the second half.

Resource stocks fell, with Rio Tinto down 1.1 per cent, despite a better-than-expected 80 per cent leap in first-half profit. BHP Billiton lost 2.2 per cent and Anglo American slid two per cent as copper fell sharply.

Among other firms posting earnings, Unilever fell 5.8 per cent as traders said its margins disappointed despite stronger-than-expected underlying second-quarter sales growth.

UK grocer Morrison rallied 3.5 per cent after beating first-half sales forecasts, while broadcaster ITV added 2.7 per cent after sources said the exit of Chief Executive Charles Allen was expected to be announced early next week.

Elsewhere, France's Thomson dropped 6.7 per cent after Goldman Sachs advised investors to sell the stock.