Market Report: RBS soars on back of Merrill's rescue plan

Royal Bank of Scotland registered a stellar 16.79 per cent rise last night after the house broker Merrill Lynch suggested a radical restructuring strategy to save the bank, already majority-owned by the British taxpayer, from full nationalisation.

Merrill outlined a series of asset sales that, combined with moves to reduce the size of the investment banking arm's balance sheet and spin off toxic credit assets, had the potential to see the business through the storm engulfing the financial markets.

A sale of the Bank of China stake ("inevitable in 2009", according to Merrill) topped the list of options alongside the planned sale of the insurance business, which, although liable to increase the bank's capital cover if sold, promises to benefit the group if retained. "On balance, we think the arguments against selling insurance are more compelling," the broker said, before outlining step three – the creation of a "bad bank" special purpose vehicle to absorb the £55bn in problematic structured credit assets.

Other options includes the sale of Citizens Financial in the United States, the proceeds of which can be used to buy back the government preference shares, and a reduction of risk at the Global Banking & Market division, the "clear problem child of the group", according to Merrill. "We are acutely aware of the execution risks which the restructuring of RBS entails and we do no expect 'new RBS' to be a fabulously high return business. However, we believe that over the next year, RBS will be able to achieve a number of the measures we outline," the broker said, helping the stock climb to first place on the Footsie, up 9.2p at 64p.

Overall, the FTSE 100 ended up 57.37 points at 4,122.86 while the FTSE 250 climbed 30 points to 5,860.39. The highlight of the session was the admission by the British Airways, up 12.46 per cent, or 17.4p, at 157.1p, that it was engaged in merger talks with Qantas, the Australian flag-carrier.

Tesco was up 12.99 per cent, or 37.4p, at 325.4p after posting a better-than-feared third-quarter update, revealing 2 per cent ex-fuel like-for-like sales growth at its UK operations.

On the downside, falling commodities prices exerted pressure on the mining sector with Rio Tinto losing 10.88 per cent, or 155p, to 1270p and Fresnillo down 7.13 per cent, or 10p, at 130.2p. The business software group Sage was weak, losing 4.83 per cent, or 8p, to 157.8p, as investors awaited the publication of preliminary results.

HSBC, down 1.43 per cent, or 10p, at 690p, was unsettled by reports that the United States Justice Department had included it in an investigation into international banks that offer offshore private banking services. The bank said it was not aware of its inclusion, adding that it had not been contacted by the US authorities with regard to any such investigation.

On the second tier, HMV was the strongest, up 14.82 per cent, or 15.75p, at 122p, after Goldman Sachs sparked a short squeeze by removing the stock from its "conviction sell" list. Goldman kept the stock on its "sell" list, saying: "We believe valuation remains unattractive but the stock could see short-term support from the prospect of market share gains following Woolworths' likely store closures." In a wide-ranging sector note, the broker also moved Burberry, up 1.25 per cent, or 2.5p, at 202.5p, to "neutral" from "sell" and Halfords, down 1.3 per cent, or 3p, at 228p on the recent news of job cuts, to "conviction sell" from "neutral".

Elsewhere, parts of the housing sector rallied on growing hopes that the Bank of England will deliver a sizeable reduction in interest rates when it rules on the matter tomorrow.

Taylor Wimpey, which remains the focus of rumours anticipating a financing deal with lenders, was the strongest, gaining 10.81 per cent, or 1p, to 10.25p while Barratt Developments advanced to 50.5p, up 5.21 per cent, or 2.5p.

Persimmon, down 3.46 per cent, or 7.25p, at 202.5p, missed out on the rally after Credit Suisse said reports that the company was moving to refinance debt in a bid to avoid covenant breaches supported its view that the "company is not more insulated from the market troubles than its peers (as some have suggested) and thus never justified the extent of the premium that it carried relative to most of its peers".

Logica was down 2.99 per cent, or 2p, at 65p after Merrill Lynch forecast dividend cuts at the IT group.

Among smaller companies, JJB Sports lost another 31.82 per cent, or 7p, to 15p amid growing concern about its financial health. According to recent reports, Barclays, a key lender to the sports retailer, has drafted in the accountants Grant Thornton for advice on the company's future business plans.