European shares closed a shade lower yesterday as gains in telecoms shares such as BT and financials, notably Royal Bank of Scotland, were offset by a fall in oil stocks and Tesco.

Merger and acquisition speculation continued, this time with British insurer Prudential in the spotlight amid talk that Axa might be on the prowl, traders said.

Prudential rose 3.1 per cent while Axa fell 0.7 per cent. "There's a lot of cash around, and deals are going on. We think corporate earnings numbers that people have got in their forecasts for 2007 are too high," said Andrea Williams, head of European equities at Royal London Asset Management.

"Average M&A deal sizes have been steadily increasing and some large-cap stocks are now in play," Citigroup said.

The pan-European FTSEurofirst 300 index closed unofficially with a loss of 0.18 per cent to 1,395.46 points, having hit a session's high of 1,404.5, the strongest since May 11 when the index hit a near-five-year high.

For the week, the index firmed 1.8 per cent, boosted by a surge in takeover activity, and is now up 9.4 per cent this year.

"The period of rapid economic acceleration and dramatic earnings revisions is most likely over," Bear Stearns said in a strategy note. "Dividend yield is likely to play an important role in total returns in this phase of the European cycle." Telecoms shares tend to come with generous dividend yields and led by BT's 1.7 per cent advance, the DJ EuroStoxx telecoms index was among leading sector gainers, up 0.4 per cent.

"With ongoing positive earnings momentum, we believe BT will continue to outperform its peers," said Bear Stearns, which has an "Overweight" recommendation on the stock.

Also in the sector, Spain's Telefonica rose 0.8 per cent, France Telecom gained 0.7 per cent and Germany's Deutsche Telekom put on 0.6 per cent.

Royal Bank of Scotland (RBS) was another standout performer, advancing 1.5 per cent to its highest level since May 8. JP Morgan upgraded the stock to "Overweight" from "Neutral", saying: "RBS has a more attractive, higher return business mix and lower market risk than peers."

Dresdner Kleinwort reiterated its "strong preference" for RBS, describing the stock as "very cheap".

Crude oil prices fell by just over $1 per barrel, putting pressure on oil stocks such as Statoil, down 3.3 per cent, and Norsk Hydro, which fell 2.5 per cent.

"We are concerned by an outlook of flat-to-down earnings, and see much reduced upward momentum to consensus estimates," JP Morgan said in a sector note on integrated oil stocks.