ECB injects €98bn but markets are gripped by panic

The European Central Bank released nearly €100bn (£68bn) in emergency funds into the banking system yesterday in an effort to kick-start the crippled credit markets, but its move only sparked panic selling on stock markets across the world.

The sudden cash injection was the largest since 12 September 2001, when the central bank released billions to stabilise the market after the terrorist attacks in New York.

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The trigger for the €98bn package was a major overnight spike in inter-bank lending rates that if unremedied threatened to disrupt the normal functioning and stability of Europe's financial system.

As with the other market upheavals in the last month, the root cause was traced to America where the fallout from the meltdown of the market for risky, or sub-prime, loans continues to widen. "This is a reflection of the fact that the sub-prime issues will not be constrained to the US financial sector. As the financial sector across Europe shows its hand over the next weeks and months we will see where the exposure exists," said Ian Richards, European equity strategist at ABN Amro. "The ECB is acting as the lender of last resort. The scale of intervention we have seen today is quite large."

In a similar move, the US Federal Reserve released $24bn (£12bn) in temporary reserves to the banking system, the most since April and at least $9bn more than had been expected. The Canadian central bank announced that it would also inject funds into its market.

The FTSE 100 shed 1.9 per cent to close down 122.7 at 6,271.2, wiping out the index's entire gain since the beginning of the year. In the last month alone it has lost 6.6 per cent.

And the global sell-off accelerated through the day, leaving panicked traders on Wall Street to dump shares in the final minutes before American markets closed last night. The New York Stock Exchange introduced restrictions on automated trading, but the Dow Jones Industrial Average still registered a 387.18 point fall, ending at 13270.68.

In Europe, where bourses also slid lower, the sell-offs were spurred by comments from BNP Paribas. The French bank announced it had frozen three hedge funds with heavy exposure to the sub-prime sector because it could no longer value the assets they contained. The bank did not say when it would lift the prohibition against investors pulling money out of the funds, which together hold assets worth €1.6bn.

In the wake of the liquidation of a pair of Bear Stearns hedge funds last month, investment professionals said the move was necessary to avoid a complete collapse of the funds and heavier losses. "If you give the money back to some of the investors, you have to sell most liquid assets first, which means what will remain in the fund is less liquid and less valuable," said Sophie Panchal, investment analyst at Nedgroup Investments.

Man Group, the world's largest hedge fund, registered its biggest one-day loss in more than a decade after it revealed another fall in the weekly performance of its main funds.

It was rising defaults on risky mortgages taken out by the poorest Americans which first led lenders of all kinds to tighten the terms of their loans or to pull funding altogether, and the problems in the US mortgage market continue to spread. On a conference call to discuss its latest results, the financial giant AIG said defaults were rising even among homeowners with better credit histories.

Demand for complex debt instruments backed by these US mortgages has all but dried up, one of the reasons why BNP Paribas has lost confidence in the valuations of the debt instruments on its books.

Ms Panchal said she expects further turmoil. "I think we still have some weeks and months to go, perhaps all the way to the end of the year, for the extent of losses to become apparent."

The seizing up of the credit markets has meant that potential borrowers either cannot get loans at all or have to pay unexpectedly high interest rates. That in turn has meant that debt-funded corporate takeovers are less likely. Home Depot, America's largest DIY chain, became the latest victim yesterday, saying the $10.3bn disposal of its supply business had hit the rocks. Banks lending to the three private equity firms which had agreed to buy it - Bain Capital, Carlyle and Clayton, Dubilier & Rice - have forced a renegotiation of the terms and Home Depot said it now expects to raise much less money.