The threat of a dramatic Greek exit from the euro sent the UK's cost of borrowing falling to an all-time low yesterday as panicky investors dumped shares and risky eurozone debt in a desperate search for safe havens.
Athens faces a deepening political crisis as attempts to form a new government in the wake of last week's inconclusive elections come close to collapse. European stock markets endured a turbulent day with traders bracing themselves for weeks of damaging uncertainty ahead of a likely return to the polls next month.
Open talk of an "amicable divorce" and a "managed exit" for Greece from the eurozone by senior European Central Bank officials, unthinkable just a year ago, fuelled tumbling share prices across the Continent with major share indices in Paris, Frankfurt and Madrid tumbling by up to 3 per cent. London's FTSE 100 fell nearly 2 per cent to 5,465.52, its lowest close of the year.
Victoria Cadman, an economist at Investec, said: "Greece's exit from the euro is being seen as more than just a far-reaching possibility now."
The success of anti-austerity parties in Greece also throws into doubt Athens' commitment to the cuts demanded in return for its latest €130bn (£104bn) bailout. Eurozone finance ministers were expected to deliver a stern message to Greece to stick to austerity or risk losing the funds.
The "Grexit" turmoil sent billions flooding into low-risk assets such as UK government bonds, sending the Coalition's cost of borrowing to a record low of 1.858 per cent at one point. Investors also took shelter in other safe-haven assets with US Treasury yields slipping to 1.78 per cent. Germany's cost of borrowing through ultra-safe Bunds is at just 1.44 per cent. The euro also sank to a four-month low below $1.29 against the dollar, another safe port in times of market turbulence.
Michael Hewson, an analyst at CMC Markets, said: "The returns on US and UK debt and German Bunds is well below the rate of inflation, showing that for markets it's now a case of capital preservation rather than capital appreciation. They just want to keep their money safe."
The flood into UK bonds painted a stark contrast with increasing pressure on Spain and Italy as international investors abandoned the eurozone strugglers. Spain and Italy saw borrowing costs fall earlier this year, after the European Central Bank pumped more than €1trn in cheap loans into the financial system. But the economic gloom has ratcheted up the pressure on Spain recently, sending its benchmark borrowing costs to a six-month high of 6.24 per cent, climbing back towards the danger mark for a potential bailout. Italy raised €5.2bn in three-year debt yesterday but faced the dearest cost of borrowing since January.
Speculators have also taken a massive $23.4bn (£14.5bn) bet against the euro as the single currency's woes intensify on the back of Greek turmoil. The latest trading figures from the Chicago Mercantile Exchange revealed a huge short position built up against the single currency in the week to 8 May, according to Lloyds Bank Corporate Markets analysis. The figures showed a net 144,000 bets against the euro, equivalent to the huge sum, by "non-commercial" traders, who are mainly speculators. This is around three times as high as the previous week.
China added to the nerves by cutting reserve requirements for its banks, freeing them to lend more in an attempt to avert a slowdown.