LONDON (AFP) - London shares struggled Wednesday as financial market chaos sparked the overnight rescue of US insurance giant AIG and a reported takeover bid for bank HBOS.

The FTSE 100 saw choppy trade before rebounding slightly after the BBC reported that bank Lloyds TSB was in advanced takeover talks with HBOS, one of the country's biggest mortgage lenders. The BBC did not cite its source and both banks declined to comment.

London rallied by 1.29 percent in late morning trade.

HBOS shares had nosedived by 52 percent in early trading to a low of 88 pence amid resurgent jitters about the health of the global banking sector.

However, the takeover report helped push the stock back up to 183.6 pence, up 0.88 percent from Tuesday's close.

Lloyds TSB's share price jumped 16.7 percent to 326.5 pence.

In the same sector, Barclays gained 11.6 percent to 343.75 pence.

Barclays said earlier Wednesday that it had reached a deal to acquire the North American investment banking and capital markets businesses of Lehman Brothers for 1.75 billion dollars.

World equities have spiralled lower this week after US investment bank Lehman Brothers filed for bankruptcy amid mounting fears that the ongoing global credit crunch could claim another corporate scalp.

"The financial system is going to continue to be the main mover in these markets and panic will continue to generate huge volatility," warned CMC Markets dealer Iain Griffiths.

"The AIG rescue has been an important development for US markets, however we still feel sceptical that it will be enough to push markets higher."

Markets opened Wednesday to learn that the US Federal Reserve would extend an 85-billion-dollar loan to the American International Group, which staved off another round of bloodletting overnight on Wall Street.

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