Top shares rose on Friday, reversing initial losses, fuelled by hopes a new Chinese investment vehicle could be used to help alleviate the impact of the euro zone debt crisis, as investors awaited the outcome of a crucial EU summit.
A source told Reuters China's central bank plans to create a new vehicle to manage two investment funds worth a total of $300 billion (191.2 billion pounds), one targeting investments in the United States and the other focused on Europe.
I guess they're hoping that China's going to be the white knight that rides to Europe's rescue, Joe Rundle, head of trading at ETX Capital, said.
I think in time China will probably step in and have an effect on Europe, but it's going to be very much on China's terms rather than European terms.
The benchmark index had oscillated in and out of negative territory earlier as hopes waxed and waned a European summit would take big strides towards solving the region's debt crisis.
At 1:05 p.m., the FTSE-100 index <.FTSE> was up 18 points, or 0.4 percent, at 5,502.21, led by banks, having recovered from an intra-day low of 5,440.86. Volumes were thin.
The index has gained about 7 percent over the past two weeks on mounting expectations of an imminent solution to Europe's debt crisis.
Disappointingly for investors, European leaders have failed to agree on a treaty change and decided to cap the euro zone's permanent bailout fund, with the fund also not aiming for a banking licence that could have increased its firepower.
Summit talks resume today, but some market participants saw little cause for reassurance, taking the view there would be no rapid solution to the euro zone's debt crisis.
I don't think we're going to get many more announcements (from the summit). I think the more helpful thing is to get more from the ECB ... The market's increasingly sceptical about whether politicians can deliver much more in the short term, said Colin Mclean, managing director of SVM Asset Management, which has around 700 million pounds of assets under management.
Sentiment was dented on Thursday when European Central Bank President Mario Draghi cooled market expectations about the prospect of an acceleration in ECB bond purchasing, although the bank did cut interest rates by 25 basis points to 1 percent.
There's been quite a lot of scrambling to cover shorts, and I think probably a lot of institutions are quite underweight on banks (which are deleveraging quite sharply in Europe now), so there's more potential upside in that sector, Mclean said.
After suffering hefty falls in the previous session, banks <.FTNMX8350> staged a recovery, with Lloyds Banking Group
Among fallers, GlaxoSmithKline
On the second line, African Barrick Gold
UBS strategists said the recent market moves probably reflect some pricing out of extreme negative scenarios, but risks remain.
We believe the market is priced for a small decline in earnings next year, UBS said.
While we see upside to end-2012 (target 6,100 for FTSE 100), we believe that we would need to see a big positive surprise from EU politicians to push convincingly through this range-bound market in the near term.
UBS said that positive developments from the EU leaders could lead to a number of financials and mining stocks performing well, while consumer staples, utilities and pharmaceuticals should outperform if the crisis deepens.
The FTSE 100 currently trades on a price to earnings ratio of 9.9 times, compared with a historical average of around 14 times, and a price to book ratio of just 1.57, according to Thomson Reuters data. Its dividend yield of 4.15 compares favourably to those offered on safer euro zone and U.S. bonds.
Atif Latif, director of equities and derivatives at Guardian Stockbrokers, sees downside risk to the index's consolidated low at 5,362, then to 5,200/5,100, the base for the last rally, on negative news out of the summit, while good news may trigger a re-test of its recent high at 5,632.
Traders said that if, on the other hand, no news of particular consequence were to emerge from the summit, this would only trigger a 'small down' on the FTSE 100, although the index would remain reasonably volatile.
(Additional reporting by David Brett and Jon Hopkins)