In London the FTSE 100 index ended 92 points down at 5,826.2, having dropped as much as 123 points earlier in the day. Wall Street opened lower, too, although US prices spent the rest of the morning treading water.
The US Federal Reserve's Open Markets Committee is not expected to take any action at its meeting today, but renewed signs that the American economy has lost none of its steam have led many analysts to pencil in a rise in the cost of borrowing later this year. If this happens, it would be the first increase since March 1997.
This caution was reinforced by earlier tumbles on Asian stock markets as a result of the continuing turmoil in Indonesia. Shares on the Jakarta exchange itself fell 4 per cent, while there was a 3 per cent drop in Malaysian stocks and a more modest fall in Hong Kong: the Hang Seng index ended down 126 points at 9,411.97. Japan bucked the trend, however, with the Nikkei index climbing 142 points to 15,384.47.
Almost none of Wall Street's pundits expect the Fed to raise rates this week, not least because of the continuing fragile state of Asia's financial markets. "It is a question of domestic economic management versus the stability of the world financial system," said Ian Shepherdson, chief economist at HSBC Markets in New York. "A US rate rise could cause another lurch down in Asia and send the dollar even higher."
Despite these fears, the dollar climbed to a six-and-a-half year high against the yen yesterday, jumping above 136. The markets' biggest fear is that an ever-strengthening dollar will force China to abandon its peg to the US currency, causing further huge upheaval in Asia.
But a growing group of analysts believe the need to act against domestic inflationary pressures will force the Fed's hand later in the year. The next meeting of the Open Markets Committee - a two-day session at the end of June just ahead of Fed chairman Alan Greenspan's twice-yearly Humphrey- Hawkins testimony to Congress - is seen as a potential danger point.
Sterling's recent slide halted yesterday ahead of figures due out today on retail price inflation and Thursday's report on retail sales. Underlying inflation last month is expected to have climbed further above the Government's 2.5 per cent target.
Even though the increase is the predictable result of higher excise duties, it will further dent confidence that UK interest rates have reached their peak.
Figures released last week showed a shock rise in earnings growth, while the Bank of England's quarterly inflation report showed that the Monetary Policy Committee remains split over the need for higher loan rates.Reuse content