FTSE plunges on fears that banking bail-out will fail to ease credit crisis

Financial markets suffered a renewed bout of nerves yesterday after more worrying news about inflation in the American economy and evidence that the $100bn (49bn) plan by the world's central banks to restore order to credit markets isn't working.

Paul Tucker, the Bank of England executive director for financial markets, warned: "We must try to avoid a vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply and slower aggregate demand feed back on each other."

Surprisingly strong figures for retail sales and factory gate price inflation left dealers doubting the prospects for further deep cuts in interest rates by the Federal Reserve.

American producer price inflation has risen to 3.2 per cent just in the month of November, the highest monthly increase since the bad days of stagflation and quadrupling oil prices in 1973. Fuel prices rose 34.8 per cent in the month. Healthy retail sales, up 1.2 per cent on the month, also suggested inflationary pressures, and less room for rate cuts by the Fed.

Wednesday's quarter-point percentage cut was less than many on Wall Street had hoped for, while the announcement of co-ordinated central bank measures to restore normality in the credit markets appears to have had little impact.

Libor, the interbank lending rate and a key indicator of the severity of the credit crunch, registered only a slight decline. The three- month sterling rate went from 6.62688 per cent to 6.51375 per cent, while the equivalent rates for the euro and US dollar fell from 4.9525 per cent to 4.94938, and from 5.0575 to 4.99063 per cent respectively. The euro rate remains at near seven-year highs.

Fears about the credit crunch also pushed financial shares and equity markets lower. The Dow Jones Stoxx 600 Index lost 2.4 per cent to 365.61, while the FTSE 100 slumped by 195.6 points, or 3 per cent, to close at 6,364.2, and European stocks declined the most in three weeks. UBS, and Royal Bank of Scotland dropped for a third day in the wake of recent warnings by Barclays Capital, Bank of America, Lehman Brothers and Wachovia. HBOS was also sharply down.

Banks are reluctant to lend to each other and are "hoarding cash" to repair damaged balance sheets. The international central bank plan has not impressed market players. "People don't think the Fed has solved the problem. Their action hasn't reinstilled confidence in the market place and that's why all these financials are getting killed. Banks don't want to lend to each other, even today," said Stephen Massocca, at Pacific Growth Equities.