Lloyds Banking Group led the banking sector higher last night, adding more than 50 per cent after the house broker Citigroup played down the fear of full nationalisation.
Lloyds was heavily bruised in last week's sell-off amid mounting concerns that, owing to its merger with HBOS, it was more exposed to toxic assets and rising bad debts – so exposed, it was feared, that the Government may have to step in with a significant capital injection, possibly wiping out ordinary shareholders in the process.
Citi disagreed, arguing that Lloyds needed an extra £3bn at the most, which if provided by the taxpayer would take the Government's shareholding to 57 per cent from 43 per cent.
"Although this would leave the group majority owned by the Government, we do not view this as making nationalisation 'inevitable'," the broker said, upgrading its recommendation to "buy" from "hold".
The argument reassured investors, lifting the stock to 100.9p, up 33.8p, and burning short sellers who had pinned their hopes on the share price turning south again.
The wider sector also strengthened, with the Royal Bank of Scotland surging to 21.3p, up 35.67 per cent or 5.6p.
UBS, which weighed in on RBS, said that at current levels the market was factoring an 80 per cent or more likelihood of either another recapitalisation exercise or nationalisation, adding: "If this probability were to decline to 40 per cent, we estimate the stock price could rise in value by [around] 50 per cent."
Barclays, which sparked the recovery with an unprecedented update on capital and profits earlier this week, climbed to 107p, up 18.89 per cent or 17p.
Overall, the banking rally helped the FTSE 100 record a 2.4 per cent gain, adding 100.79 points to 4,295.20, while the FTSE 250 swung to 6,423.76, up 165.19 points.
The market traded up despite a grim forecast from the International Monetary Fund, which now expects the UK economy to contract by 2.8 per cent this year.
Howard Archer, the chief UK economist at IHS Global Insight, said the prediction was "depressingly realistic", adding that he was "slightly more pessimistic still".
"We now expect the UK economy to contract by 3.1 per cent in 2009 and then be only flat overall in 2010," he said, anticipating a particularly sharp decline in the first six months of this year.
Xstrata was the weakest on the benchmark index, falling 9.05 per cent or 62p to 623p on rumours of a possible rights issue.
The chatter was not new – the Anglo-Swiss miner has often attracted such speculation owing to its debt load – but gained fresh potency owing to an announcement from rival miner Rio Tinto, which conceded that a rights issue was an option as it attempts to bolster its balance sheet.
At the close, Rio was down 1.46 per cent or 24p at 1,615p.
Retailers firmed up after Citi switched its stance on the sector to "neutral" from "underperform", anticipating earnings to trough this year.
Kingfisher, which was moved to "buy" from "hold", climbed to 141.1p, up 5.93 per cent or 7.9p while Next, which was raised to "hold" from "sell", gained 5.83 per cent or 66p to 1,198p.
DSG International, up 4.55 per cent or 1p at 23p, was boosted by Goldman Sachs, which moved its target price for the stock to 18.9p from 18p. Debenhams was also strong, gaining 1.59 per cent or 0.5p to 32p, despite Goldman reducing its target for the stock to 30p from 40p.
Elsewhere, Friends Provident gained 6.5 per cent or 5.3p to 86.8p as investors continued to pile in on the back of its update, which was published to a rapturous reception earlier this week.
JP Morgan was unconvinced, however, arguing that the share price reaction overlooked the potential "time lag impact of the recession" on the group's sales.
"We believe the fourth-quarter pension sales of £463m [on an annual premium equivalent basis] reflect companies hiring staff some six-12 months ago," the broker said, downgrading the stock to "neutral" with a 105p target price from "overweight" with a 110p target.
The pubs group Greene King swung to 421p, up 19.69 per cent or 69.25p, after posting a better-than-feared update, prompting Numis to move the stock to "buy" from "add".
Altium, which upgraded the stock to "buy" from "hold", was also impressed with what it called a "very creditable performance".
Among smaller companies, Taylor Wimpey gained 1.64 per cent or 0.25p to 15.5p after Panmure Gordon moved the stock to "hold" from "sell", arguing that the potential dilution from a deal with its lenders was now fully priced in to the shares.
"We continue to believe that any refinancing package will come at a high cost to the business," the broker said.
"Not only in terms of arrangement fees and the margin payment over Libor but also in terms of dilution to existing shareholders, with a dilutive equity fundraising likely to be required in order to secure refinancing."
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