FTSE lags Europe as stronger pound compounds losses

By Helen Reid

LONDON (Reuters) - British shares pulled back on Wednesday, weighed by banks and miners, as investors repriced expectations for fiscal easing from the U.S. and a stronger outlook for sterling compounded weakness in the UK stock market.

Britain's blue-chip FTSE 100 index (.FTSE) fell 0.7 percent to its lowest level in nearly two weeks, little moved by reports of two dead and several people injured in an attack near the British parliament.

The FTSE underperformed the pan-European STOXX (.STOXX) index, which ended down 0.4 percent, while Britain's mid-cap index (.FTMC) fell 0.8 percent.

"It's a double whammy of the pound not looking so bearish on the 12-18 month view, along with the pullback in global markets," said Kallum Pickering, senior UK economist at Berenberg.

The weak pound has consistently been supporting the index, whose constituents mainly earn foreign currency, up to record levels this year, with the latest all-time high hit on Friday.

But the pound hit its highest levels in almost four weeks on Tuesday after inflation for February shot past the Bank of England's 2 percent target. That has removed an important catalyst for the FTSE to climb higher.

On Wednesday, the pound fell following the Parliament incident before recovering shortly after.

Banks have also been adjusting their forecasts for sterling upwards. Morgan Stanley set out more bullish estimates this month, downgrading their stance on UK large-caps as a result.

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British equities were tracking global markets lower, as investors grew concerned that much-anticipated reflationary policies from the new U.S. administration would take longer to materialise than hoped.

Banking and mining, which had seen the greatest gains from the 'Trump trade' as investors bet on reflation and infrastructure spending, were the biggest sector fallers.

"There's a degree of fiscal frustration - what's been driving markets is the hope and promise of fiscal stimulus, tax cuts and deregulation, and investors were expecting many more details than what we have by this point," said Alex Dryden, global market strategist at JP Morgan Asset Management.

"Markets have been very tranquil so far this year, and that suggests to me that any sort of move was going to cause some shockwaves," he added.

On average over a decade, the FTSE sees a 1 percent move once every five days, but in 2017 so far there have been only two daily moves of such magnitude, Dryden said.

Positive economic data and an upturn in basic resource prices contributed to this calm start to the year for the index, which has a 20 percent exposure to commodities.

Miners Rio Tinto (RIO.L), BHP Billiton (BLT.L) and Ashtead (AHT.L) fell 0.5 to 2.5 percent.

Barclays (BARC.L), Standard Chartered (STAN.L) and RBS (RBS.L) fell 0.9 to 2.4 percent.

Home improvement retailer Kingfisher (KGF.L) fell 5 percent after it said it was concerned uncertainty around French and British politics could hit future demand, after it beat 2016 profit forecasts thanks to solid performance in its home market.

As investors turned to safe haven assets and dividend-yielding stocks, gold miners Randgold Resources (RRS.L) and Fresnillo (FRES.L) were among a handful of companies making gains, along with telecoms group BT (BT.L).

"This is a classic risk-off move - people fly to safety, to the names that they know, as they reprice their fiscal policy outlook," said JP Morgan Asset Management's Dryden.

British Airways owner International Consolidated Air (ICAG.L) and Easyjet (EZJ.L) fell 2.7 and 2.4 percent respectively. Both airlines would be affected by Britain joining the U.S. in imposing restrictions on carry-on electronic devices on planes coming from certain airports in the Middle East and North Africa.

(Reporting by Helen Reid; Additional reporting by Danilo Masoni; Editing by Tom Heneghan/Ruth Pitchford)