Banks propel European stocks to 10-week high

European stocks reached a 10-week high yesterday, as banks rallied on hopes the worst of the credit crunch might be past, but gains were limited by a drop in energy shares on the back of lower crude oil prices.

The mining sector also retreated amid mixed metal prices and after a sharp advance over the past two weeks.

The FTSEurofirst 300 index of top European shares closed 0.3 per cent higher at 1,568.26 points, its highest close since July 25, after rising as high as 1,575.94.

Shares of financial institutions led the rally as investors were relieved by increased clarity about the impact of the squeeze in the credit markets on banks' results.

"It has been a crisis of information. We know there is a wolf in the sheepfold but we don't know where. So when a bank comes out with negative news, the market is relieved because at least it sheds light on the situation," said Pascal Blanque, chief investment officer of Credit Agricole Asset Management. UBS, which warned on Monday it would report a third-quarter loss after write downs of four billion Swiss francs (Lm1 billion), gained three per cent, while Royal Bank of Scotland surged 2.9 per cent and Barclays jumped 3.4 per cent.

"The key determinant here is to what extent has the credit crunch concern actually hit the real economy," said Stephen Dowds, head of international equities at Northern Trust Global Investments.

"And the evidence we have seen in the US is that the central bank doesn't want that to happen, and elsewhere there appears to be relatively little impact so far from it."

Also among the banks, Britain's biggest home lender HBOS said rising financing costs were likely to result in a "fundamental shift" in the UK mortgage market, but would provide it with "real opportunities for value creation". Its shares gained 4.3 per cent.

On the downside, shares of energy companies lost ground as US crude oil futures fell for a third consecutive session as a rise in the dollar and worries over the outlook for the global economy prompted investors to take profits.

Royal Dutch Shell fell 2.9 per cent, Total dropped 1.6 per cent and BP shed 1.1 per cent.

The mining sector moved in the same direction, with BHP Billiton down 4.4 per cent, Rio Tinto down 2.6 per cent and Anglo American down 2.4 per cent.

Around Europe, Germany's DAX index ended up 0.3 per cent and France's CAC 40 up 0.5 per cent, while the UK's FTSE 100 index dropped 0.1 per cent.

Europe's benchmark index, up 5.7 per cent so far this year, is still down 4.1 per cent since reaching a multi-year high in mid-July.

Equity markets worldwide have been hit over the summer by fears that a debacle in the risky US subprime mortgage market could dampen banks' results and spread to the broader economy.

But some market players said the crisis may be fading and stocks would soon revisit multi-year highs.

"The situation has stabilised over the past month and might have improved slightly globally. The end of the year will be crucial as a huge amount of debt will have to be rolled over," said Credit Agricole's Mr Blanque.

"When the crisis will be over, we'll see a burst of liquidity and that will have to go somewhere. We believe that the equity market, which has been hammered, will benefit from any signs announcing the end of the crisis."

But Morgan Stanley still sees risks for banks from the credit crunch.

"We think the risk of further earnings disappointment is likely - particularly as the market digests the idiosyncratic risk of who suffered in the liquidity squeeze and re-assesses further pressure on margins, RWA (risk-weighted asset) growth and credit into 2008/2009, particularly for some banks exposed to the UK and Spanish housing market," it said in a note.

"Nevertheless, for some of the sector (particularly the cash generative players), we believe the heavy underweight trade for the moment is behind us."