The FT-SE 100 Index of top British stocks fell 148.1 points, or 2.9 per cent, to 5020.2 on Friday, having been down as much as 3.5 per cent earlier in the day, one of the worst days of the past five years.
Gains notched at the beginning of the week were wiped out. Gilts gained with US Treasuries. Stocks and bonds were driven by a plunge in Japanese stocks that bolstered expectations that investors will buy bonds as a refuge from turmoil in equities.
The benchmark ten-year UK gilt yield fell two basis points to 6.27 per cent.
"The Treasury market was strong yesterday and overnight, and in a sense we're getting a bid from that," said Joanne Collins, an economist at Nomura International. The decline in Japanese stocks "helped the Treasury market, and therefore [German] bunds, and therefore gilts."
"We're already starting to see some profit warnings about Asia," said Philip Harris, a fund manager at Albert E Sharp. Even so, the impact will probably not affect the British economy as a whole. "The underlying market is still good."
Shell Transport & Trading dropped 26p to 420 while Rio Tinto, the mining company, fell 40p to 700. HSBC Holdings, the parent of Hongkong Bank, slid 45p to 1,523.
On Tuesday, the Government will release statistics on the trade deficit for November and October. A broader trade gap probably will come "from expanding imports and contracting exports", according to Ms Collins. "We've seen a hint of the deficit widening already and I think we'll see more of that next week."
Gilt yields are also likely to fall in the New Year as evidence grows that the strong pound is helping damp demand for British exports.
Yields on ten-year gilts may fall to about 6 per cent in the first months of next year. "The combination of higher interest rates and a strong currency will slow the economy and keep inflation from accelerating," said Rod Davidson, manager at Murray Johnstone Asset Management in Glasgow.
On Monday the Government will release the final revision to its estimate of third-quarter economic growth. Some analysts say growth is likely to slow in the months ahead.
The OECD said last week that tumbling currencies and rising interest rates in Asia would dampen growth both this year and next, and reduce inflation in 1998.
On Friday, money-market rates fell, amid expectations of a slowdown in retail spending during Christmas lessening the need for official interest- rate increases in the New Year.
Copyright: IOS & Bloomberg