By Clare Hutchison
LONDON (MarketWatch) -- British stocks dropped on Thursday as the European Central Bank president dashed investors' hopes that the institution would buy more government bonds.
The FTSE 100 fell 1.1% to finish at 5,483.8.
The index fell 0.4% Wednesday after investor optimism about a potential increase to the European financial-rescue mechanisms fizzled out.
In a widely-expected move, the European Central Bank on Thursday lowered interest rates by 25 basis points to 1%. The decision follows a quarter-point cut in November and reverses rate hikes delivered earlier this year.
In a conference following the announcement, the ECB president said the European Union treaty prohibits "monetary financing", dampening hopes that the central bank would purchase more European governments' bonds.
The news appeared to weigh heavily on markets across Europe on Thursday just as EU leaders are set to meet at a summit in Brussels to discuss proposals to solve the sovereign debt crisis.
"The bad news -- and it has been taken badly by the markets -- is that the ECB President Mario Draghi's comments dilute hopes that the ECB could massively step up its bond purchases or lend to euro-zone countries via the International Monetary Fund if EU leaders achieve major step forwards on establishing new fiscal rules and tighter governance at Friday's summit," said Howard Archer, chief U.K. and European economist at IHS Global Insight, in emailed comments.
The Bank of England voted Thursday to keep interest rates at 0.5% and maintain its £275 billion ($430 billion) bond-buying program. The central bank said the asset-purchase scheme would take another two months to complete and the scale of the program would be kept under review.
Banking stocks tumbled following the ECB press conference. Lloyds Banking Group PLC shed 7.4% and Royal Bank of Scotland Group PLC slid 5.5%. Barclays PLC lost 3.7%.
Shares in engineering firms also suffered on Thursday. IMI PLC fell 4.5% and Weir Group PLC dipped 2.4%.
Automotive and engineering products manufacturer GKN PLC fell 3.4% after Credit Suisse downgraded its rating on the stock from outperform to neutral.
Telecommunications firms and tobacco producers were among the few winners on Thursday. BT Group PLC and Vodafone Group PLC climbed 0.8% and 0.3% respectively, while British American Tobacco PLC rose 1.5%.
Pharmaceutical companies were also up. Shares in GlaxoSmithKline PLC increased by 0.8% and Shire PLC climbed 0.3%.