Merrill Lynch is increasingly positive on the outlook for the financial sector, highlighting Barclays, Halifax and Societe Generale as buys. The biggest threat to the banks is that earnings will be hit by increased risks of bad loans. The brokers say, in light of that caution, investors should steer away from investment banks.

But Merrill Lynch believes a soft landing is more likely. It suggests the banks form one of the most undervalued sectors - forecast to grow by more than the market (11 per cent) in the medium term - and is upgrading it.

The insurance sector, while offering slightly less value than the banks, is more protected in the event of a hard landing. It has been rallying strongly worldwide, but the European sector has underperformed its US counterparts by more than 22 per cent in the last quarter.

Merrill Lynch says non-life insurance earnings appear to have bottomed. In the life sector, the brokers recommend Zurich, Allied and CGNU as buys for investors.