The 160.8-point rise in the FTSE 100 index of leading shares to a record high of 5,225.6 was the biggest one-day rise in the top flight since the Tories unexpectedly won the 1992 general election.
Heavy trading was triggered by a story in the morning press, thought to be a deliberate steer, that the Government was about to adopt a more positive stance towards economic and monetary union (EMU). The report, described as "speculative" but not denied by the Government, quoted an unnamed minister as saying that an announcement could be made soon on Britain's conditions for entry soon after the first wave begins in January 1999.
Economists, who have seen other tell-tale signs that ministers were warming to EMU, said the story had the ring of truth. "One suspects the story is well-sourced and the markets are quite rightly taking it at face value. The efficient news management we've come to expect from this Government continues," said John Shepperd, chief economist at Yamaichi International.
The pound fell more than 4 pfennigs against the mark to DM2.83 and by more than 2 cents against the dollar to $1.60 as currency dealers gambled that the pound would enter a single currency at a rate between DM2.50 and DM2.60, compared with its high point in July of DM3.07.
Britain crashed out of the exchange rate mechanism five years ago because the pound's semi-fixed rate was unsustainably high. Markets took the view yesterday that Tony Blair would not make the same mistake as his predecessor, John Major, and would insist on a less onerous exchange rate.
Because a lower pound would help Britain's hard-pressed export sector, as well as making a further rise in official interest rates unlikely, the FTSE 100 index of blue chip shares soared in response to the changed expectations.
The index of leading shares was 178 points higher at one stage, having burst through 5,100 for the first time and shortly afterwards breached 5,200 as well.
The main beneficiaries of the buying surge were exporters, boosted by the pound's fall, and financials, which stand to gain from a stable environment of low inflation and interest rates. That would flatten the cyclicality of banks' profits and increase the rating the market was prepared to attach to the sector.
Shares in HSBC jumped 137p to 2,160.5p, Barclays were 127.5p higher at 1,656.5p and NatWest, also buoyed by speculation that a European bidder might have the British bank in its sights, rose 82p to 940.5p.
The steep rise in bond prices was picked out by analysts as the principal reason for the moves. "Banks are highly bond-sensitive and the bond market would be the big beneficiary of convergence and an early EMU entry," said one banking analyst.
He added: "There would be an early convergence of bond rates across Europe and UK bonds hitherto have not been joining in the party."
UK gilts soared on the EMU speculation, the benchmark December contract leaping nearly two points to a new contract high of 119-27/32 in early trade. Insurance stocks, also heavily geared to bond and stock markets, joined in the euphoria, posting gains across the sector.
General Accident added 88.5p to 1,079p, Guardian Royal Exchange 23.5p to 315.5p, Commercial Union 35p to 785p and Prudential 48p to 679.5p.
Other risers among leading shares included big exporters, which will benefit from the lower pound making their products more attractive in overseas markets. TI jumped 54.5p to 661p, GKN was 88p higher at 1,417.5p and Siebe and LucasVarity both rose by more than 5 per cent.
In keeping with the bull market so far this year, the rise was reserved almost exclusively to leading shares, with the FTSE SmallCap index, up 14.2 to 2321.1, hardly rising at all. The FTSE 250 index of second-liners also missed out on most of the action, closing 92.9 higher at 4,809.1. As in the top tier, however, manufacturers were to the fore in the FTSE 250 with Vickers, McKechnie, Glynwed and Delta all closing higher.
Industry called on the Government to clarify its position. The Confederation of British Industry (CBI), which called on Labour in July to announce its intention to sign up for the single currency, said: "The CBI would welcome such an announcement on EMU. In order to plan effectively, business now needs greater certainty."
Analysts suggested the leak was part of efforts to soften up the public for an earlier-than-expected entry into monetary union, as it becomes increasingly clear that the project is starting to gain a momentum of its own.
Stephen King at James Capel said yesterday's market movements showed how effective a hint that the UK will go into EMU could be in talking the pound down from its recent highs. It was doubly effective because it would bring aid to the UK's increasingly battered export sector while allowing interest rates to remain high to keep the lid on the nascent consumer boom.
Others were less sure that much had changed. Alison Cottrell at Paine Webber commented: "One of the only ways this Government can differentiate itself from the other one is over EMU. Every time you get a speech or a hint from the Government which is not just loathing EMU, it is interpreted as snuggling up to it."
She did not think there had been a sudden shift in favour of the project or a new enthusiasm to be in the first wave in 1999. But she suggested the Government might be keen to hold the promised referendum on monetary union at the time of the next elections for the European Parliament in June 1999.
Phillip Chitty at ABN Amro pointed out that the UK would anyway find great practical difficulty in meeting the requirements for an early entry to EMU.Reuse content