European stocks fall to 3-week low; UBS sags

By Blaise Robinson

PARIS, May 22 (Reuters) - European stocks dropped in early trade on Thursday, falling to a three-week low as inflation fears continued to rattle investors after a gloomy outlook by the Federal Reserve and a surge in oil prices.

But a rally in commodity-related stocks helped cushion the fall. Rio Tinto (RIO.L: Quote, Profile, Research, Stock Buzz) gained 1 percent, BP (BP.L: Quote, Profile, Research, Stock Buzz) rose 0.7 percent and ENI (ENI.MI: Quote, Profile, Research, Stock Buzz) added 1.6 percent.

At 0806 GMT, the FTSEurofirst 300 index of top European shares was down 0.5 percent at 1,334.54 points, after falling to as low as 1,330.77 points, a level not seen since April 30.

"The current oil prices and the Fed that basically admitted they are going to pause are not good news for stocks," said Franz Wenzel, strategist at AXA Investment Managers, in Paris.

"But the pullback is not really a surprise. Stocks had been rallying since mid-March."

The Federal Reserve on Wednesday slashed its U.S. economic growth forecast for 2008 and signalled that mounting concerns over inflation would make further interest rate cuts unlikely.

"The FOMC minutes reveal that the April rate cut was a close call. New economic projections show that the Fed is much more pessimistic on this year's growth and inflation rates," UniCredit said in a note to clients.

Oil vaulted to a high above $135 on Thursday, extending this month's near 20 percent rally after a steep fall in U.S. crude inventories and the weakening U.S. dollar triggered short covering by investors.