The merger discussions were confirmed last night by C&W, which is worth more than pounds 11bn, after weeks of stock market speculation over the on-off relationship between the rival companies.
The merger would require Government permission and would inevitably result in the disposal of Mercury Communications, C&W's UK subsidiary and the single biggest competitor for BT.
The admission from C&W followed feverish rumours in the City, which were accompanied by surges in the share price of both groups. The company said that the talks were "exploratory" and "may or may not lead to a merger".
BT confirmed last night that talks between the two companies' advisers had taken place.
Sir Iain Vallance, BT's chairman, is believed to be have held talks since the end of last year with Brian Smith, C&W's chairman, and Rod Olsen, acting chief executive. His approach followed Cable & Wireless' descent into chaos after a bitter boardroom struggle.
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