Stocks surged on both sides of the Atlantic as fear about higher interest rates was conquered by end-of-quarter greed. Investors regained their appetite for risk, sending natural resources companies such as Xstrata and BHP Billiton to the top of London's leaderboard.
The FTSE 100 Index jumped 2 per cent, closing higher by 112.9 at 5791.5 -- its highest level since May 16. The broader FTSE 250 firmed as much as 106.3 at 9303.5, buoyed by demand for technology shares along with upbeat trading news from Hovis bread maker RHM.
On Wall Street, the Dow Jones Industrial Average climbed as much as 121.8 to 11095.4, extending on a two-day advance. That came after data revising first quarter growth up to 5.6 per cent, in line with the consensus, with inflation pressures in check.
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The Federal Reserve decision is due after the European close, at 7:15pm London time. Interest rate futures markets have for weeks priced to certainty that we will see the seventeenth consecutive quarter-point hike, while a half-point move is rated extremely unlikely. The accompanying statement is expected to talk tough on inflation, leading traders to price in an August quarter-point rise at about 75 per cent.
"To not tighten at [today's] meeting would present the Fed with an enormous credibility problem– essentially making a 25 basis point rate hike a done deal," wrote Adam Boyton, an economist at Deutsche Bank. "We expect the statement to give the Fed full flexibility to either hike or pause at its August 9 meeting."
Some believe the Fed could tone down the language used in its previous statement, which emphasised that future decisions would depend on inflation data. Chris Turner, head of forex at ING, says the committee may "want to take back control of monetary policy from the bond and money markets" by back-peddling "from the data dependency clause".
"Although tonight’s statement has the scope to be a little bit dovish ... disappointment with the scale of any changes is the greater risk, and hedging tonight’s decision would seem the most appropriate and prudent policy," he advised clients.
On this side of the pond, sterling rate futures rallied and sterling hit a two-month low against the euro after comments by Mervyn King, the Bank of England Governor, suggested UK interest rates will be stuck at 4.5 per cent for at least another two meetings.
Mr King told Parliament that the overall economic picture had changed little since the Bank's May Inflation Report, with a degree of uncertainty on the outlook.
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Mining stocks led the FTSE 100 risers. Stronger gold and copper prices helped, even though trading on the LME was wafer thin ahead of the Fed.
Metals derivatives and mining stocks have been the sharpest fallers over the last few months as investors sold investments they believed were most at risk as world economic growth slowed. With second quarter ending tomorrow, theories abound that institutional fund managers tempted into the metals markets at the start of the year would be giving their worst-performing investments a temporary boost by throwing good money after bad.
The cynical may suggest that was already happening a day early. Copper miners Vedanta Resources jumped 84p to £13.36, Kazakhmys added 66p to £11.76 and Antofagasta rose 19.75p to 414.75p. Copper futures rose 5 per cent.
BHP Billiton finished ahead 48p to £10.31 after the world's biggest miner held analyst briefings in Sydney and London. Management talked of cost pressures continuing to grow, albeit at a slightly slower rate, and was cautious on delivering new projects at cost and on time within its key iron ore, coal and manganese units.
"While the company message will no doubt prompt the market to review its costs and growth profiles across the three key businesses the outstanding question to our mind remains on the pricing outlook which is undoubtedly positive and will probably continue to outweigh cost [and] supply pressures," said Deutsche Bank, which repeated "buy" advice on a £12.75 target.
Strategists at Citigroup were more concerned with mining sector consolidation, which in recent months has created bid battles develop for steel, gold, copper and nickel firms.
"Where many see this as a top-of-the-cycle sell signal, we see a rational response to flabby balance sheets, resource scarcity, [sustainable and responsible investment] development constraints and free cash flow yields on quality metal assets running above the cost of capital," its team told clients. "With significant cash war chests and limited project pipelines we believe there is substantial financial ability [and] rationale for continued industry consolidation."
Citigroup compiled lists of the hunters and hunted. In the first column were Rio Tinto and Xstrata, along with American peers Newmont, Phelps Dodge and Chalco. The UK companies in the "prey" list were Anglo American, Vedanta, Peter Hambro Mining and Lonmin.
"It would not be surprising to see non-conventional investors enter the fray, in the form of private equity, management buyouts, or Chinese entities seeking to lock in raw material sources," Citigroup added.
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The oil stocks were also in demand despite crude prices sticking inside their recent range, with Shell ahead 45p to £18.86 and Cairn Energy up 18p to £21.55. A barrel of New York benchmark crude held above $73, up more than a dollar on yesterday amid renewed optimism about US economic stability.
BP was up 8.5p to 627p even after the US futures industry regulator said late yesterday BP’s American unit tried to manipulate propane prices by cornering the market in February 2004.
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Drax Group and British Energy were the only blue chip stocks to register declines after the British government cut annual quotas of emissions permits.
The UK proposed to cut its carbon dixoide emissions cap under the second round of the European Union's trading scheme, running from 2008 to 2012. The annual quota of emissions permits would fall to 238 million tonnes CO2 per year, from 245 million tonnes during the first phase. That, along with new auction restrictions, will cut the number of permits available to the power sector by about a quarter.
Drax, which owns coal-fired power stations, lost 20.5p to 824p. British Energy, which only runs nuclear stations and does not need to buy CO2 permits, slipped 2.5p to 671p in sympathy.
Goldman Sachs said the news, if finalised by Europe, would cut its valuation of Drax by 34p per share, or 4.4 per cent. That was based on Drax getting permits on 10 million tonnes per annum, a 31 per cent cut from the current level and 15 per cent below its previous valuation.
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BT Group added 7p to 237p after hosting a series of investor meetings in London, at which management gave an upbeat view on prospects but no new guidance. There was also some wild rumours about a private equity bid doing the rounds, although these looked apropos nothing.
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Guinness and Smirnoff maker Diageo closed up a modest 5p to 915.5p as concerns about rising costs and dollar weakness took the shine off its year-end trading statement.
The world's largest liquor maker raised its 2006 sales growth target from 4 per cent to 6 per cent but kept its earnings growth target unchanged at 7 per cent (analysts at UBS had been forecasting 8.1 per cent). Higher input costs and marketing expenses were to blame.
Dresdner Kleinwort (which, as of today, no longer comes with the Wasserstein) used the statement as a trigger to cut its recommendation to "add" from "buy", even though it was keeping earnings forecasts unchanged.
The German broker said that Diageo stock had been the strongest in the beverages sector during the market's recent wobble, outperforming by 5 per cent against peers and 11 per cent against indices since early May.
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PartyGaming climbed 0.75p to 114.25p on reports that the group is set to unveil plans to expand into sports betting through acquisitions, to be funded with a bond issue worth up to £500 million.
The poker room operator was last week linked with buying bricks and mortar casino operations, and has in the past been suggested as a predator for Betfair, the privately owned betting exchange whose flotation plans seem to have gone awry.
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RHM, maker of Mr Kipling cakes and Hovis bread, led the FTSE 250 leaderboard after its slightly better-than-expected full year results came with a reassuring message on trading. Underlying earnings totalled £173.5 million on sales of £1.56 billion, in line with its most recent profit warning but shading the consensus of £171 million and 1.54 billion respectively.
Shares ended up 21.5p to 286p.
RHM said it had made a "satisfactory start" to the current year and revealed a new long-term target of between 2 per cent and 4 per cent sales growth. Cazenove, which repeated "outperform" advice, had been on 2.5 per cent compound rate between 2007 and 2009.
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EasyJet underperformed, closing down 0.5p at 385.25p even after Cazenove told clients that trading at the airline may be running ahead of market expectations. It raised forecasts "materially" and upgraded the shares to "outperform" from "in-line".
"Recent traffic data in our view suggests that current trading is running strongly ahead of management’s last guidance," Caz said in a research note. Its analyst added that shares are a "modest" 7 per cent premium to Ryanair on 2006 earnings estimates, despite much stronger earnings growth.
Further out, Caz saw the possibility of forecast upgrades as management pushes through a long-term incentive plan. "Current consensus and our own forecasts for these years implicitly point to a considerable degree of scepticism that the targets can be met. ... We see scope for the shares to appreciate to about 450p with a stretch target of 560p if the maximum return on equity of 15 per cent is reached in 2008."
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Punters' favourite Victoria Oil & Gas retreated 44p to 97p after the explorer said it had suspended two wells, triggering a cut in its estimated reserves.
Victoria said it was putting off any further exploration and shallow well drilling at the Danniella prospect, within the company’s key West Medvezhye project, after two wells drilled yielded little of commercial value. It is the second disappointment in as many months for the group, which was formed by former Yukos executives. They admitted in May that tests at another Siberian field would be delayed due to melting permafrost.
Independent auditor DeGolyer & MacNaughton had now revised its estimate of gross resources to 1.0 billion barrels of oil equivalent from 1.1 billion barrels previously. Today's price decline sent the shares back to the level they were at in November, when the company first revealed data showing its West Medvezhye field contained 500 billion cubic feet of recoverable gas.
On broker watch:
Dresdner moved to "buy" from "hold" on Balfour Beatty and switched AstraZeneca to "add" from "reduce".
Seymour Pierce cut both Rexam and Reliance Security to "hold" from "outperform".
Panmure Gordon switched both Greene King and Amiad Filtration to "buy" from "hold", and made the opposite call on Straight.
Citigroup raised Tullow Oil to "buy" from "hold".
And ABN Amro moved Morgan Crucible to "add" from "hold".
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