The LSE has long been stalked by its German rival

The LSE said the 530 pence-a-share cash offer - valuing it at about �1.35bn - "undervalued" both its own business and the benefits of such a tie-up.

But both companies said they would continue talks, a prospect which sent the LSE's shares soaring more than 25%.

Deutsche Boerse has long wanted to link up with London, and the two tried and failed to seal a merger in 2000.

The attempt had foundered on concerns from UK traders and on a hostile bid from Sweden's OM Group.

Preservation

News of the approach by Deutsche Boerse sent the LSE's shares to a record level of 537 pence - above Deutsche Boerse's offer.

LSE'S LINKS WITH DEUTSCHE BOERSE July 1998 - LSE and Deutsche Boerse (DB) form an alliance March 2000 - Paris, Amsterdam and Brussels set up Euronext May 2000 - LSE and DB announce plans to merge, forming iX Aug 2000 - Sweden's OM exchange puts forward an �808m hostile bid for the LSE Aug 2000 - LSE has to pull out of iX as shareholders consider - but reject - the OM bid Q&A: Stock exchange takeover

The previous six weeks had seen a 25% gain as rumours of an impending bid from the German rival spread.

Deutsche Boerse shares, for their part, fell 3.8% to 42.84 euros.

Responding to the LSE's rebuff, Deutsche Boerse - whose market capitalisation is more than �3bn - said it believed it could show its proposal offered benefits, and that it still hoped to make a cash bid.

Its proposals would help lower the cost of listing on the exchange, it said.

But the LSE said not only was the bid undervalued, but that it had "been advised that there can be no assurance that any transaction could be successfully implemented".

Approval

Major shareholders in the LSE backed the board's refusal.

"We view the LSE as a company with unique potential and therefore concur with its management's view that the bid undervalues it," said Richard Dunbar, investment director at Scottish Widows Investment Partnership, which owns 4.7% of the exchange's equity.

But he agreed with the plan to hold further talks with the German exchange.

Track the exchange's share price

"We support the management's view that it is worth entering further discussions to get more colour on the proposals."

The suggestion that trading tariffs could fall was of particular interest in future discussions, he said - as was detail of what technology would be deployed should a bid be successful.

But one UK-based fund manager working for a US fund management company was concerned that consolidation could go too far.

A Deutsche Boerse-LSE tie-up, he said, would "provide economies of scale in trading".

"But on the other hand, you might get a powerful exchange that behaves in an oligopolistic fashion and tries to dictate terms.

"There's also a risk that we might end up paying more for settlement as Deutsche Boerse provides trading and settlement under one umbrella."

Consolidation

Monday's move is the latest in a succession of attempts to consolidate European markets.

The LSE, as Europe's biggest stock market, is a key prize, listing stocks with a total capitalisation of �1.4 trillion - more than twice that of Deutsche Boerse.

A counterbid is thought likely - perhaps from Euronext, which owns London's derivatives market LIFFE.