The top share index gained marginally on Tuesday, led by defensive stocks whose gains outstripped losses sustained by financials and miners after Standard & Poors ratings agency warned of a potential downgrade to most euro zone countries.
S&P warned it may downgrade 15 out of 17 euro zone countries, including top-rated Germany and France, if EU leaders fail to agree on a plan to solve the debt crisis at a summit on Friday.
S&P cited five reasons for its credit watch including tightening credit conditions across the euro zone, continuing disagreements from policymakers as to how to handle the crisis and the rising risk of economic recession in the euro zone as a whole.
So maybe this is why the S&P warning has had little market impact - investors have already been acting on the five S&P concerns, said Louise Cooper, market strategist at BGC Partners.
In a signal that investors remained cautious given the uncertain economic outlook, defensive stocks led London's blue chip index <.FTSE> tentatively up 3.15 points, or 0.1 percent to 5,571.11 at 11:32 a.m., having closed at a five-week high on Monday
BGC's Cooper was not convinced the current rally in equities can be sustained with so many of Europe's debt problems, which saw the market fall as much as 18 percent at one point in 2011, still unresolved.
I am beginning to feel a bit like a party pooper failing to get carried away with the excitement from the Merkozy meeting (on Monday), she said.
These new treaties are merely putting right the mistakes of the past, when the euro was created, they do little to deal with the massive debt problem in the euro zone currently.
Evidence the debt problems were weighing on the region came as the EU said the euro zone's economy barely grew in the third quarter, with collapsing business confidence and slowing industry pointing to a recession and likely giving the European Central Bank grounds for an interest rate cut this week.
Philip Poole, global head of macro investment strategy at HSBC Global Asset Management, said for the current equity rally to be sustained macro economic indicators needed to improve and EU leaders had to set down clear markers for deeper fiscal integration. Until then a defensive environment would persist, he said.
Safer stocks dominated the leaders as investors' mood turned cautious, with Vodafone
In the pharmaceutical sector, Goldman Sachs reiterated its buy rating on Shire, given continued market uncertainty, and its preference for structural leaders in the sector
Seymour Pierce, which said the results were ahead of its expectations, raised Wolseley's rating to hold from sell.
The riskier assets such as banks <.FTNMX8350> and miners <.FTNMX1770> were weaker after S&P's warning as investors switched into risk-off mode.
Miners such as Kazakhmys
HSBC's Poole said, however, that if risk stabilises then commodity stocks look attractive on valuation grounds, given their exposure to emerging market growth.
Confidence in the financial system needs to be restored before the banks regain investors' faith, he added.
British retailers fell after a survey published overnight said they suffered their biggest annual fall in underlying sales since May last month after widespread discounts failed to lure in pre-Christmas shoppers.
Analysts at Singer Capital Markets cut their clothing sector profit forecasts, taking them 5 percent below consensus on average to reflect how difficult October and November have been, and how margins will probably come under intense pressure in December.