Dismal data on US services spook markets

Stock markets on both sides of the Atlantic endured another difficult day as a round of depressing economic data pummelled the exchanges yesterday.

The FTSE 100 fell 2.6 per cent to finish below the 6,000 mark again, while the Dow Jones Industrial Average shed 2.9 per cent. The French CAC and German Dax indices fell by nearly 4 and 3.4 per cent respectively. Renewed worries about the dangers of recession and the continuing credit crisis were the main contributors to the loss of nerve among traders and investors.

News from the United States set the mood, with the Institute for Supply Management's (ISM) business activity survey showing the service sector contracted in January for the first time since March 2003.

The index was projected to fall to 53, being the consensus view of economists polled by Bloomberg. A reading of 50 is the dividing line between growth and contraction, and the index has averaged 57.6 since its inception in July 1997 – but last month it collapsed to 41.9, from 54.4 in December. Most observers took this as a strong indicator of an approaching recession.

Richard Iley, of BNP Paribas's American economics team, said: "The numbers are truly awful. This is the point of the business cycle when variables tend to turn non-linear. The economy reaches its tipping point and then accelerates sharply into the downswing, surprising all forecasters and policy makers."

The ISM figures caught the markets off guard, released several hours early because of concerns they may have leaked. The Dow began trading 200 points in the red and only got worse. It closed at its low point for the day, down 370 at 12,265.

Signs of renewed stress in the credit markets were also weighing on traders' minds after Wall Street banks failed to find buyers for the leveraged loans they have proffered to fund last year's private equity buy-outs. Such debt will have to remain on the banks' own books, crimping their ability to make new loans. Libor, the closely-watched interest rate at which banks lend to each other, crept up for the second day in a row, after eight weeks where it has been subdued. A higher Libor indicates reluctance of banks to lend.

Economic news in the UK exacerbated declines in the London stock market. The Halifax house price index followed last week's Nationwide survey in putting the property market at a standstill. With no change in real estate values in January, prices in the three months to January were 1 per cent lower than in the previous quarter. This was the third successive fall in house prices on this rolling average basis. Prices are up 4.5 per cent on January 2007.

The travails of the housing market are feeding into households' morale. The Nationwide Consumer Confidence Index registered its lowest ebb since the survey began in 2004.

Cross-European surveys of service-sector activity showed that throughout much of the Continent euro-zone services growth slowed to a near halt in January, with services in three of the eurozone's four biggest economies contracting. Of the largest four single-currency nations, only France showed growth. The UK's service sector was stagnant.

Vicky Redwood, of Capital Economics, said: "The stabilisation in activity shown in the CIPS report supports the case for the Monetary Policy Committee to cut interest rates at a gradual pace."