Market Report: Investors dig in to Xstrata on Vale tie-up hopes

Citigroup contributed to a surge in Xstrata's share price yesterday, suggesting that, notwithstanding the collapse of the takeover talks with its Brazilian rival Vale last week, "a future tie-up amongst the two companies remains a distinct possibility".

Citi's suggestion was strengthened by overnight comments by the Vale chief executive, Roger Agnelli, who said that the two companies could restart negotiations "at any moment".

According to Citigroup, the breakdown of talks was prompted by the de-rating of Vale's share price during the long negotiating process, not the onerous demands of the Swiss commodities trader Glencore, which owns a significant stake in the Anglo-Swiss miner. The broker said that while the marketing rights – which appeared to be the sticking point with the shareholder – have a certain tangible value, it was not sufficient to prompt Glencore to walk away from the deal.

Citi said: "We believe that if we see a re-rating of Vale stock in the next few months, the company would be more willing to re-enter discussions with XTA [Xstrata] and possibly offer a price reflecting XTA management's view of its own worth."

Hopes of a deal rescued Xstrata from the doldrums: it closed up 120p at 3,594p.

Elsewhere, bid rumours gave a lift to Whitbread, the owner of Premier Inn hotels and the Costa-branded chain of coffee shops. Market speculation suggested that Asif Aziz, the property magnate who has reportedly built an 8 per cent stake in the company via contracts for difference, was preparing to mount a bid for the business. According to the rumour, Mr Aziz may offer up to £19 per share for the FTSE 100-listed company and had plans to break up the business. The chatter kept Whitbread shares firm at 1,210p, up 10p.

The FTSE 100 rose by 63.3, or 1.1 per cent, to 5,915.9, while the FTSE 250 was up a more modest 35.8, or 0.4 per cent, at 10,372.

Banking stocks, buoyed by hopes that the financial sector had made it through the worst part of the credit crunch, were again among the best performers on the London benchmark. Royal Bank of Scotland rose to second place on the FTSE 100 leader board, up by 20.5p to 381.5p. Barclays was at third place, gaining 24p to 504p.

HBOS was notably exempt from the rally. Britain's biggest mortgage lender lost 11.5p to 593p following comments by the finance director, Mike Ellis, who said that retail margins are likely to remain under modest pressure this year. Speaking at the Morgan Stanley banking conference in London yesterday, Mr Ellis said: "Margins are more difficult to predict in such uncertain market conditions, particularly given the extent of Libor/base-rate risk, but the longer-term prospects are more favourable, given the significant asset repricing currently under way."

In the wider market, housebuilders were hurt after a bearish note from Credit Suisse prompted a sell-off in the sector. "We believe that continued problems in the credit markets and their subsequent impact on the mortgage market will result in materially lower volumes in 2008," the broker said.

It added: "Such a drop-off in volumes will, in our view, increase the pressure on selling prices, which we expect to fall this year. Not only do declining prices have a disproportionately large impact on profits (on account of the operational leverage), but they raise the prospect of land deflation and the related risk of land writedowns."

The note hit Persimmon, which was down 15.5p at 778p. Bellway fell 17p to 903p, while Bovis Homes lost 11.5p to 626p. Berkeley retreated 26p to 1,170p, and Taylor Wimpey lost 1p to 195.25p.

On the FTSE 250, news of a $600m (£302m) equity underwriting deal drove Imperial Energy down by almost 29 per cent or 367p to 900p. Positive comment from Russia's UniCredit, whose analysts said that investors were "overreacting to the announcement", failed to stem the decline.

Fund managers, on the other hand, clocked up gains as the stock market appeared to recover from its fear of the credit crunch. Positive investor sentiment took Aberdeen Asset Management up by 6.5p to 150p, while Bluebay Asset Management added 15p to 365p. Henderson Group climbed 5.5p to 118.5p.

On AIM, the wireless broadband specialist Freedom4 Communications was downgraded to "neutral" from "buy" at Goldman Sachs. The broker said that, following the distribution of £156.9m from disposals, "the company is expected to retain cash and receivables of £38.6m and a 52 per cent share in a WiMax joint venture which has yet to prove its commercial viability,". It added: "On a sector-relative basis, the shares are down 4.6 per cent since being added to the 'buy' list." The negative assessment contributed to the share price slumping 4.27p to 2.84p.