FTSE 100 outperforms European peers as inflation slows

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* FTSE 100 up 0.2 pct

* Banks lead gainers as inflation slows down

* Housebuilders gain after Bellway (Frankfurt: 869646 - news) update

* Fenner (Stuttgart: 0UR.SG - news) jumps 24 pct on $1.7 bln Michelin (Paris: FR0000121261 - news) bid

By Tom Pfeiffer

LONDON, March 20 (Reuters) - Britain's FTSE index was Europe's best performer on Tuesday, with banks leading the gains after data showed a small slowdown in inflation that was unlikely to deter the Bank of England from raising rates this year.

House builders rose after Bellway said a strong order book would help it achieve record annual output and reported an increase in average selling prices.

The FTSE 100 was up 0.2 percent at 0957 GMT, with house builders Taylor Wimpey (LSE: TW.L - news) , Berkeley Group and Persimmon (Frankfurt: 882058 - news) among the biggest gainers. Bellway jumped 2.9 percent.

Banks contributed most to keeping the index in positive territory, outperforming all other big European stock markets. Lloyds was up 0.9 percent and HSBC 0.7 percent.

Software (IOB: 0NJS.IL - news) company Micro Focus, which lost 46 percent of its market value in the previous session after its chief executive quit and it cut its revenue outlook, staged a small recovery, gaining 3.6 percent.

M&A action continued with Fenner jumping 24 percent to the top of the FTSE 250 after French tyre maker Michelin made a 1.2 billion-pound ($1.7 billion) bid for the engineering company.

"Our first take is that the deal looks good and offers a healthy premium especially in light of Fenner's very strong recent share price performance," said Stifel analysts.

Shares (Berlin: DI6.BE - news) in Ocado fell 1.3 percent after the British on-line supermarket reported a hit to trading from recent snow storms.

Britain's hopes of avoiding a disorderly exit from the EU next year got a boost on Monday when the government sealed a Brexit transition deal with its EU partners.

The FTSE fell to a 15-month low later in the day as the Brexit deal boosted sterling, weighing on the share prices of internationally exposed companies. But some market watchers said UK stocks may now be a good longer-term bet.

The transition agreement "will remove a little bit of that economic uncertainty," Edmund Shing, head of equity derivative strategy at BNP Paribas (LSE: 0HB5.L - news) .

"And by the way, let's not forget that even if the UK doesn't have fantastic GDP growth forecasts, they are inching up rather than down, so actually maybe there is less reason for massive pessimism around UK large-cap stocks."

British inflation was weaker than expected in February, according to official figures that appeared unlikely to alter the view of the Bank of England, which meets this week, that wages will grow more quickly than prices this year. Economists expect the central bank to raise interest rates as early as May.

Some investors may be wary of placing big bets before the U.S. Fed's two-day policy meeting this week, with the central bank expected to raise rates for the first time this year.

Mike Bell, global market strategist at JPMorgan Asset Management, sees a chance of four Fed rate rises this year.

"I think equities can handle it as long as they don't start to signal that they are concerned about inflation and signal more than four rate hikes this year," Bell (LSE: 0QPQ.L - news) added.

(Reporting by Helen Reid, editing by Larry King)