The FT-SE 100 index of leading shares fell 35.4 points to 2,797.3, the first time it had closed below 2,800 since interest rates were last cut three months ago.
The pessimism spilled over into gilts, which were undermined by an unenthusiastic reception to yesterday's latest auction of bonds by the Bank of England. Both factors overshadowed any reaction that the markets might have shown to a cut in a key German interest rate by the Bundesbank.
More than 23,000 FT-SE 100 futures contracts, about twice the daily average, changed hands on the London International Financial Futures and Options Exchange (Liffe). The contracts give investors exposure to the stock market's future movements without actually buying or selling shares.
The June futures contract closed at a new low of 2,792 as persistent rumours that George Soros - the US investor noted for making dollars 1bn by selling the pound on Black Wednesday - was in the market as a seller. A spokeswoman at Mr Soros's office in New York said: 'We never comment on our position.' But some traders on Liffe said the Soros rumours had been heavily exaggerated in the weak market in recent days. Many trading firms had 'stop' orders in the market to sell FT-SE futures if the price fell below 2,800.
'The price hit 2,776 over the lunch hour and the stop orders exaggerated the falls,' one trader said. The surge of selling then pulled the stock market itself lower.
Others put the selling down to the 'buy the rumour, sell the fact' rule of market behaviour. A trader for a European bank said: 'A lot of good buying took place when all the bad news about the economy came out.'
The fascination with Mr Soros came after his recent agreement to buy a pounds 259m stake in the gold mining company Newmont Mining, which has triggered speculation that he was buying gold and selling bonds on world markets.
The gilts auction of pounds 3bn of stock was just 1.77 times subscribed, attracting bids of pounds 5.3bn where there had been hopes of pounds 7.5bn. A campaign by the Bank of England to market more gilts to private investors tempted 2,000 people to buy pounds 12m worth in the auction, 10 times the usual number of individual bids.
The gilts market was disappointed with the auction and prices fell about 1p in the pound, leaving the market back at the levels before the rally that began on Monday.
Dealers blamed yesterday's unexpectedly large reduction in the German repo rate for raising fears of higher inflation in Germany. This hit German bonds and spilled over into other markets.
The auction was also of five-year gilts rather than the long-dated stock preferred by institutions.
The Bundesbank's cut of more than a quarter point off the repo rate sent a strong signal that it was looking to accelerate the pace of official rate reductions. 'The Bundesbank has shifted into a higher gear,' said Thomas Mayer, an economist with Goldman Sachs in Frankfurt. The Bundesbank president, Helmut Schlesinger, warned, however, that high government borrowing was preventing rates falling even faster.
The repo rate - the miminum rate at which the Bundesbank lends money to commercial banks - was cut at the weekly securities tender to 7.75 from 8.09 per cent following reductions last week in both the central bank's leading interest rates.Reuse content