The top share index rose slightly on Tuesday as investors took ratings agency Moody's threat to downgrade Britain in their stride, with cheap valuations and central bank support holding up assets like the banks.
Bank stocks pared early losses in tandem with the broader benchmark index <.FTSE>, which recovered 5.25 points, or 0.1 percent, to stand at 5,910.95 by 11:28 a.m., bouncing off an intraday low of 5,882.03.
Those gains coincided with a bullish start for U.S. futures, which suggested Wall Street would rise when it opened later on Tuesday. U.S. January retail sales numbers and import and export prices are due for release at 1:30 p.m., and December U.S. business inventories are due at 3 p.m.
The main focus in the UK was Moody's warning it may cut the triple-A ratings of France, Britain and Austria. It downgraded six other European nations including Italy, Spain and Portugal, citing growing risks from Europe's debt crisis.
Investors are getting used to living with downgrades now, and the latest decision by Moody's won't change their views of the UK, said David Miller, Partner at Cheviot which has around 3.5 billion pounds of assets under management.
However volumes on the index were weak -- just 28 percent of their 90-day average around midday -- suggesting cautious market participants were keeping to the sidelines. Investors rotated heavily into last year's losers, banks and miners, in January.
Philip Poole, global head of macro investment strategy at HSBC Global Asset Management, said he expected the reallocation into riskier assets to continue and pointed to the buoyancy of assets closely associated with sovereign ratings as a reflection that downgrades have been largely priced in by the market.
Ratings agencies in their actions tend to be backward looking and markets tend to be forward looking, which means things get priced in much more quickly, he said.
Highlighting that fact, on Tuesday UK gilt yields barely moved, while Italy's three-year borrowing costs dived compared to a month ago at its latest auction as ECB loans continue to support demand for government paper.
UK banks, which have large exposure to sovereign debt, bounced off the day's lows, showing the sector has investor support at the current levels, where it trades on a 12-month forward price to earnings of 9.7 times, compared to the FTSE 100 on about 10.4 times, according to Thomson Reuters data.
Exane BNP Paribas upgraded the UK lender to outperform from neutral saying: With Barclays Capital starting the year strongly, management targeting 2 billion pounds of non-performance cost savings and no evidence of deteriorating credit quality, we believe the downgrade cycle to be over.
Shore Capital agreed and upgraded its rating on Barclays to neutral from sell and said that despite the recent rally of about 60 percent since mid-November, the valuation -- on 0.6 times December 2011 tangible net asset value, and with a forecast 2012 return on total equity of 8.4 percent -- did not appear stretched.
Valuation spurred JPMorgan's upgrade of Bunzl
We believe that the recent relative underperformance could be a good entry point ahead of FY results on 27 February, JPMorgan said in a note.
The market continued to reward companies that could spring a positive earnings surprise.
British outsourcing group Capita
Many of the top FTSE 100 risers had a defensive feel to them, with Wolseley
Miners, which have largely led the gains, were weaker, were the main drag on the index with Rio Tinto
(Written by David Brett; Editing by Sophie Walker)