Miners prevented the FTSE 100 falling sharply on Thursday, as merger news and talk of China easing its monetary policy boosted the sector, while the broader market fell as investors banked recent gains in the wake of weaker corporate earnings.

Xstrata was up 10.7 percent after confirming it is in discussions with commodities trader Glencore regarding an all share merger of equals. [ID:nL4E8D22B3]

Glencore International climbed 4 percent.

Cannot see why Xstrata shareholders would want to sell out for no additional incentive. Not sure what additional synergies there are for Glencore either as they have 34 percent shareholding and marketing rights to Xstrata already, a London-based trader said.

Will give other mining groups food for thought and will presumably put focus on other commodity trading groups like Trafigura.

The rest of the mining sector <.FTNMX1770> was firmer too, hoisted by the M&A news and with traders citing talk of potential for further easing of monetary policy in China, which could free cash and encourage spending on growth.

There have been signs lately that growth in the world's most voracious consumer of raw materials has been slowing as the effect of previously tighter monetary controls has taken hold.

London's blue chip index <.FTSE>, however, fell 12.64 points, or 0.2 percent to 5,778.08 by 9 a.m., having gained more than 2 percent over the previous two days, with technical analysts saying the index needs a decisive close above 5,800 if it is to start attacking highs last seen in late July.

Analysts warned that the recent rally had been built on shaky foundations.

UBS said the recent gains -- the FTSE 100 was up 3.9 percent in 2012 led by miners and banks -- had been a low-volume rally driven by hedge fund buying and long-only investors had been on the sidelines.

Hedge fund gross leverage is now close to its post-Lehman highs and net leverage has also been on the rise, it said.

JPMorgan said the risk-on 'trash rally' experienced seems to have taken everyone by surprise.

It added: We strongly believe that we are going to experience a repeat of 2011 and that 'value' will end the year strongly below current levels. We advise clients to position their portfolios accordingly.

EARNINGS DISAPPOINT

The rally in banks <.FTNMX8350> stalled as German peer Deutsche Bank badly missed fourth-quarter forecasts, according to traders, as the bank swung to pretax loss amid the sovereign debt crisis.

Banks have been rushing to repair their balance sheets with the aid of European Central Bank's (ECB) long-term refinancing operation (LTRO) and the sale of assets.

Investors supported Royal Bank of Scotland's sale of historic British stockbroker Hoare Govett to American investment bank Jefferies Group . [ID:nL5E8D15VH]

RBS rose 0.9 percent.

But Morgan Stanley said the offer of more cheap liquidity through the ECB's LTRO at the end of the month (February 29) won't be enough to stop banks shrinking through deleveraging.

In other earnings news, weaker-than-expected fourth quarter results from Royal Dutch Shell , down 2.3 percent, helped drive the heavyweight integrated oil sector <.FTNMX0530> lower.

Anglo-Dutch consumer products giant Unilever fell 4 percent as the make-up of the group's fourth-quarter (Q4) results disappointed investors and the firm warned of a difficult 2012.

AstraZeneca shed 3 percent as it announced it was cutting a further 7,300 jobs and expected earnings to fall 14-18 percent this year as patents on key drugs expire and governments in Europe and the United States squeeze prices.

With the outlook tough for companies in the face of economic austerity brought on by Europe's debt troubles, firms are being forced to cut their workforces to save costs to help protect future earnings and margins.

Smith & Nephew gained 4.2 percent as Europe's biggest artificial knee and hip maker trimmed costs to boost profits in the final three months of 2011, putting it back on track for what it expects to be a tough 2012.

Compass Group added 1.1 percent after the world's biggest caterer reported rising first-quarter sales as strength in America offset European weakness.

On the domestic data front, January's Market/CIPS British construction PMI report will be released at 0930 GMT, with a reading of 52.6 forecast, down from 53.2 in December.

(Writing by David Brett; Editing by Helen Massy-Beresford)