Falling oil drives world stocks higher

By Natsuko Waki

LONDON (Reuters) - World stocks hit a three-week high on Wednesday as a firmer dollar and concerns about slowing energy demand knocked oil prices still lower after the steepest fall in history from July's record highs.

The dollar hit a 1-1/2 week peak against a basket of major currencies, weighing on oil prices, after a top Fed official said rising inflation could force the central bank to start raising interest rates sooner rather than later.

U.S. crude is now down more than $20 after hitting a record above $147 a barrel and fanning inflation concerns. Wednesday's decline comes after prices suffered their steepest loss in dollar terms last week since futures began trading in New York in 1983.

"We can start to think about inflation pressure easing," said Philip Isherwood, strategist at Dresdner Kleinwort.

"It starts to take some of the pressure off central banks and (let) them think more about economic weakness than about inflation expectations."

The FTSEurofirst 300 index .FTEU3 was up 1.6 percent, while the MSCI main world equity index .MIWD00000PUS gained 0.4 percent, rising for six days in a row.

Banks were top gainers, with HBOS HBOS.L soaring 11 percent on market talk of bid interest from Spanish rival BBVA (BBVA.MC).

Also helping sentiment, second-quarter corporate results from both sides of the Atlantic are proving to be not as disastrous as some had expected.

Internet company Yahoo (YHOO.O) reported adjusted profit in line with the forecast, while construction and mining equipment firm Caterpillar (CAT.N) and Swiss bank Julius Baer (BAER.VX) posted better-than-expected results.

RISING RATES

Philadelphia Fed President Charles Plosser, one of the Fed's staunchest inflation hawks, said rate rises could happen even before labor and financial markets recover, adding that keeping monetary policy too loose for too long could worsen the inflation problem.

"Though inflation is a shared concern, Plosser, a known hawk, is still in the minority among his peers as others want to see the credit crisis resolved first, and raising rates is not viable under such a priority," said Masafumi Yamamoto, head of foreign exchange strategy for Japan at Royal Bank of Scotland.

Interest rate futures show that investors are expecting the U.S. central bank to raise the benchmark cost of borrowing by a quarter percentage point by October from the current 2.0 percent.

Against the yen, the dollar hit a one-month high of 107.90. Emerging sovereign spreads tightened 6 basis points while emerging stocks .MSCIEF were up 1.7 percent.

The September Bund future fell 20 ticks as safe-haven demand waned in the face of firmer stocks and other risky assets.