Evidence of a rebound in new home construction in the US lifted equity markets on Tuesday, continuing a strong run fuelled by merger activity.

The recent wave of M&A remained the dominant theme as Barclays, the UK bank, and its Dutch rival ABN Amro confirmed they were in preliminary talks.

US bid activity centred on technology groups Affiliated Computer Services, Palm and Gateway.

Investors looking ahead to Wednesday’s Federal Reserve decision on US interest rates were not expecting a change to the current Fed funds rate of 5.25 per cent, but, given recent mixed economic readings, were positioning themselves for the possibility of a shift in stance in the central bank’s post-decision statement.

US data on Tuesday showed that housing starts rebounded 9 per cent in February after a 14 per cent fall in the previous month. Stock markets were helped by the data: at the close on Wall Street the Dow Jones Industrial Average had risen 0.5 per cent, while the Nasdaq Composite added 0.6 per cent.

But strategists believed the numbers were not strong enough to convince the Fed of “tentative signs of stabilisation” in the housing market, as noted in its January statement.

Dimitry Fleming, at ING Financial Markets, said: “The slump in the construction sector is not yet over. The next few months should see a further scaling down in construction activity with new home supply still too high.”

Mr Fleming added that with US inflation expected to fall below 2 per cent in the next six months and the construction slump driving lay-offs, a rate cut this year was a possibility.

The dollar was not greatly affected by such suggestions as the foreign exchange market’s attention was captured by a report China planned to stop accumulating foreign currency reserves.

The story, reported in Emerging Markets magazine, focused on comments by People’s Bank of China chairman Zhou Xiaochuan, who said reserves in China were already large enough.

Strategists said the market was misinterpreting the comments. The story more likely referred to the transfer of excess reserves to a new investment management agency, which was announced this month, said Chris Turner at ING.

The dollar fell 0.3 per cent against the yen to Y117.15.

Sterling was lifted 0.7 per cent to $1.9585 after UK inflation rose unexpectedly in February. Consumer prices rose from an annual 2.7 per cent in January to
2.8 per cent, higher than expected given easier energy prices this year.

London’s equity market underperformed its European peers as expectations of further near-term interest rate increases rose. The FTSE 100 index added 0.5 per cent to 6,220.30. The pan-European FTSE Eurofirst 300 index climbed 0.8 per cent to 1,487.69.

China’s main stock index climbed back to within 1 per cent of its record high after falling nearly 9 per cent on February 27 and enduring three weeks of turbulence. The Shanghai Composite rose 0.6 per cent, closing at 3,032.2, just shy of its closing high of 3,040.6 set on February 26. Tokyo’s Nikkei 225 Average closed 0.9 per cent higher at 17,163.2.

The US housing data provided a tonic for commodity markets, lifting base metals as hopes that a recovery in homebuilding would presage an upturn in the wider economy and lift demand.

Copper touched a three month high of $6,715 a tonne on the London Metal Exchange, before easing to $6,650, down $20 on the day.

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