Markets catch cold again as US fears persist

Shares across the world gyrated wildly again yesterday as fears of a recession in the American economy ebbed and flowed across the financial markets.

The slump in equity values started in Asia, where traders were unsettled by renewed fears of a recession in the United States. Japan's benchmark Nikkei index fell by 4.0 per cent, while the Hong Kong Hang Seng Index declined by more than 4 per cent, and Shanghai was down 7 per cent.

A growing belief that the Chinese economy could no longer be assumed to be "decoupled" from the US contributed to the unsettled atmosphere, as did some freakish weather in the region. Snow in south and central China, espec-ially in the industrial hub of Shanghai, disrupted power supplies, closed factories and halted air and road traffic.

Continuing their roller-coaster ride, shares in London reversed some of the gains made at the end of last week – the rally that followed Monday's six-year record fall in equities. A fall of a further 1.4 per cent in the FTSE 100 extends its losses this year to more than 11 per cent, and the volatility looks set to continue.

Tim Hughes, head of sales trading at IG Index, said: "All seems to be rattled again. Perhaps it's unsurprising, given the seemingly baseless rally towards the end of last week. We are not going to know for a few months whether recession is the next problem that we are going to be dealing with, or if the US fiscal stimulus package and aggressive interest rate slashing are going to be effective."

The FTSE 100 closed at 5,788.9, 80.1 points down, having at one moment plunged by 163 points. But a more optimistic start in Wall Street trimmed the day's losses. The Dow Jones closed 177 points higher at 12,383.9.

The slightly improved mood on both sides of the Atlantic was firmly rooted in hopes for the success of President George Bush's proposed tax cuts discussed in his State of the Union address and, more urgently, for a cut in rates when the US Federal Reserve's Open Markets Committee meeting concludes tomorrow.

Last week's "emergency" cut of three-quarters of a percentage point is expected to be followed by a further half-percentage point reduction at this scheduled meeting of the Fed.

Official data released yesterday, however, gave no cause for cheer. The latest figures on new US home sales were described as "worse even than imagined" and "simply awful" by analysts. In December, demand for new homes fell by almost 5 per cent on November, dropping to its lowest level since February 1995. New home sales dropped at a 35 per cent annualised pace in the three months to December. In 2007 as a whole, new homes plunged 26 per cent, the worst annual performance since records began in 1963. The price of a typical American home is down around 10 per cent on the year.

"The Fed will likely err on the aggressive side," said Dean Maki, chief economist at Barclays Capital in New York. "It is very concerned about addressing downside risks quickly."

The markets are pricing in a rapid reduction in American interest rates. Dollar Libor, the interbank cost of borrowing dollars, fell yesterday, but sterling rates remained high in the light of hawkish comments from senior figures at the Bank of England dampening hopes of rapid rate cuts.

Today, Gordon Brown will meet the German Chancellor Angela Merkel, the French President Nicolas Sarkozy and the Italian Prime Minister Romano Prodi, to discuss the world economy.