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 gained 1 percent, BP rose 0.7 percent and ENI 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 US economic growth forecast for 2008 and signaled 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 US crude inventories and the weakening US dollar triggered short covering by investors. Airline stocks lost altitude again, tracking a sell off in the sector on Wall Street overnight on worries over high oil prices and after Lehman Brothers cut its price targets on eight US airline companies, citing rising fuel costs and the prospect of a recession. Air France, which posted a drop in 2007/08 net profit due to a provision, tumbled 9 percent, while Lufthansa shed 3.2 percent and British Airways lost 3.4 percent. Banks were the heaviest negative weight on the market on Thursday, with UBS losing 2 percent. The Swiss lender launched a deeply discounted rights issue worth 16 billion Swiss francs ($15.55 billion), aiming to issue new stock at about a third below its latest market price. Banking stocks have been hit over the past year by the US sub-prime mortgage market that has forced financial institutions to write down assets and seek emergency capital injections. UBS has lost 40 percent since the start of 2008, while the DJ Stoxx bank index has lost 20 percent over the same period, and the benchmark FTSEurofirst 300 index dropped 11 percent. Germany's DAX index was down 0.7 percent on Thursday, UK's FTSE 100 index flat and France's CAC 40 down 0.7 percent. On the year, the DAX is down 13 percent, the FTSE 100 down 4 percent and the CAC 40 down 11 percent.
