Expectations of a U.S. interest rate cut this week boosted world stocks for a third straight session on Monday and sent the dollar to record lows, while surging energy and gold prices buoyed emerging markets.
The Federal Reserve is widely seen cutting rates by 25 basis points to 4.5 percent on Wednesday and expectations are building for a follow-up cut in December to limit economic damage from the housing market's downturn.
This, along with renewed mergers and acquisitions activity in the mining sector, helped European stocks carry over the positive mood from Asia, where shares hit record highs. Wall Street was set for a firmer open.
The current optimism (for equities) is still based on markets hoping for an interest rate cut on Wednesday, said Thomas Gruener, analyst at Landesbank Berlin.
MSCI's main world equity index was up 0.7 percent on the day, edging closer to a record high set earlier in October.
The FTSEurofirst 300 index was up 0.8 percent. Mining shares gained after Anglo-Swiss minor Xstrata offered A$3.1 billion for Australia's fifth-largest nickel producer Jubilee Mines. Oil stocks were also firmer.
Emerging markets showed particular strength. Broader emerging market stocks and Asian stocks hit record highs on MSCI measures, bringing this year's gains to more than 45 percent -- triple the increase in the MSCI main index.
We shouldn't forget that weakness we saw was down to the housing market and sectors relating to that. There are other sectors and emerging markets which are contributing to the ongoing boom in the global economy, said Elwin de Groot, senior market economist at Rabobank in Utrecht.
COMMODITY PRICES AND INFLATION
Emerging markets have been buoyed by oil and gold prices, which have been surging partly thanks to dollar weakness.
The prospect of U.S. monetary policy easing has been weighing on the dollar because rate cuts reduce its yield premium over other major currencies.
The dollar fell as low as $1.4438 per euro and hit a 33-year trough against the Canadian dollar around C$0.9580. It also posted record lows against a basket of major currencies.
U.S. light crude rose to a record high again on Monday, surpassing $93 a barrel as Mexico briefly halted one-fifth of its production, while gold struck a 28-year high just below $800 an ounce and platinum hit record highs.
Analysts say the surging energy and resources prices are forcing central banks to tread a very fine line.
The risk that rising commodity prices will pass through consumer prices is now bigger. However the outlook is very uncertain given the credit crisis, so central banks cannot do much about it. But if they wait too long, inflation expectations may start to become entrenched and then it is very difficult to get rid of them, Rabobank's de Groot said.
Expectations for U.S. rate cuts sent interbank lending rates for three-month dollar deposits to their lowest since March 2006. Libor three-month dollar rates fell to 4.96 percent at their daily fixing in London.
The iTraxx Crossover index, the most widely watched indicator for European credit market sentiment, moved sharply tighter to 318 basis points as stocks rallied.
Emerging sovereign spreads tightened by 3 bps.
The December Bund future was up 5 ticks despite firmer stocks, garnering support from a stronger euro.
-- Additional reporting by Eva Kuehnen