Britain's blue chip FTSE 100 <.FTSE> index was up 0.2 percent at 7,748.51 points, a new closing record and outperforming the broader European market, while mid-caps <.FTMC> declined 0.6 percent.

British banks joined in a rally with European peers as bond yields rose. The gains in financials added 37 points to the FTSE.

"When there's movement in the bond yields, the UK banks do benefit from that in a number of ways. Firstly, they make higher revenues in terms of their returns," John Moore, trader at Berkeley Capital, said.

"We think UK banks could do quite well despite the uncertainty, purely because we see them as undervalued."

Royal Bank of Scotland (>> Royal Bank of Scotland Group plc) led the FTSE 100, up 4.6 percent after Morgan Stanley upgraded its rating on the stock to "overweight".

Morgan Stanley said RBS was the most resilient UK bank in an uncertain outlook.

RBS peers HSBC (>> HSBC Holdings) and Standard Chartered (>> Standard Chartered PLC) also gained 3.7 and 3.3 percent as banks across the region rallied, with the pan-European banks index <.SX7P> at a two-year high thanks to rising bond yields.

Wednesday was another day dominated by Christmas updates from retailers, with shares in grocer Sainsbury's (>> J Sainsbury plc) advancing 1.9 percent after it beat forecasts slightly in its Christmas trading update.

"Sainsbury's has delivered reassuring trading through what, post the Argos acquisition, is its key quarter for sales and profitability," analysts at UBS said in a note.

This continued a positive theme for food retailers over the festive period as shoppers resisted cutting back on food purchases despite inflationary pressures on the consumer.

Peer Morrisons (>> WM Morrison Supermarkets PLC) enjoyed a rally in the previous session after its own update.

Sainsbury's however cautioned the market for general merchandise and clothing would be tough in 2018, and mixed results from non-food retailers on Wednesday reflected this difficult environment.

Ted Baker (>> Ted Baker plc) shares jumped 9.7 percent to lead the mid-cap index, thanks to a surge in online purchases for the fashion retailer, helping Christmas sales.

Other clothing retailers fared considerably less well, with small-cap Moss Brothers (>> Moss Bros Group plc) tumbling 16 percent and Superdry (>> Supergroup PLC) down 9.3 percent at the bottom of the FTSE 250.

Liberum analysts said the weakest retail segments have been electronics, clothing and fashion.

Housebuilder Taylor Wimpey (>> Taylor Wimpey plc) found itself at the bottom of the FTSE 100, however, down 4.2 percent on the back of a trading statement.

The housebuilder said its full-year results for 2017 would be in line with expectations.

Elsewhere a warning from the UK's Financial Conduct Authority (FCA) put pressure on shares in spreadbetters, with IG Group (>> IG Group Holdings plc) dropping 4.4 percent, Plus500 (>> Plus500 Ltd) down 5.5 percent and CMC Markets (>> CMC Markets Plc) down 2.3 percent.

The FCA said its review of the industry found "areas of serious concern" in Britain's contracts for differences (CFDs) market.

(Graphic for UK Retailers Price Performance, click http://reut.rs/2Ddbw4h)

(Reporting by Kit Rees and Helen Reid; editing by Mark Heinrich, William Maclean)

By Kit Rees and Helen Reid