Markets tumble on fears of recession in the US

Unexpectedly bad employment figures from the US sent a chill through markets yesterday as fears grew that the credit crunch was sending the world's biggest economy into recession.

US jobs grew at their weakest pace since August 2003 and unemployment jumped to a two-year high of 5 per cent as the turmoil in financial markets took its toll on the wider economy. The news sent the Standard & Poor's 500 index and the Dow Jones Industrial Average tumbling as the dollar also fell and US Treasury bills rallied. The S&P shed nearly 2.5 per cent to close at 1,411.6. The Dow fell just under 2 per cent to 12,800.2. Fears spread to London with the FTSE 100 falling more than 2 per cent after starting the day strongly.

Hopes of the US avoiding a recession had been pinned on the economy's continuing ability to create work. The 18,000 extra jobs created in December were only about a quarter of the number economists had forecast. The employment figures followed disappointing manufacturing results earlier this week.

The figures were seen as evidence that the housing slump and reduced access to credit were reverberating through the wider US economy. President Bush has said he is considering measures to stimulate the economy.

"This tells you that the strains from credit problems and so forth that have been developing in the last six months are starting to bite and they are biting in a way that finally draws consumption into question," Neal Soss, chief economist at Credit Suisse in New York, told Bloomberg.

The news increased the chance that the Federal Reserve will slash interest rates by a half point this month in a bid to ward off recession. The US central bank has already cut rates by 1 percentage point since September. Yields from two-year Treasury notes fell to their lowest in more than three years on expectations of a rate cut. The dollar slipped to a one-month low against the euro.

"The rise in unemployment was a big jump and it was a surprise," Doug Smith, Standard Chartered's head of research for the Americas, said.

"There is a credit issue in the US and cuts from the Fed can't solve that completely. If banks don't want to lend to each other or to individuals there is not much they can do about that."

Even before the figures were released, Japanese stocks fell heavily on concerns about the US economy. Toyota cut its forecast for car sales in the US, which is Asia's largest export market. Toyota's shares fell 4.3 per cent and Nissan dropped 9.2 per cent its biggest fall for six years after the car makers reported a drop in US sales. Japan's Topix index had its worst start to a new year.

Shares in Bed Bath & Beyond, the biggest US home furnishing retailer, fell 4.4 per cent as customers faced with falling house prices and higher energy costs stayed at home.

Retailers, pubs and other consumer stocks led the FTSE's decline as investors bet that the credit crunch would take a heavy toll on high-street spending this year. The British Retail Consortium Retail Sales Monitor for December will be closely watched on Tuesday before Thursday's interest rate decision.

Hopes of a rate cut by the Bank of England next week were dampened by unexpectedly strong growth in service industries for December. The Chartered Institute of Purchasing and Supply's index, based on replies from about 700 service companies, rose to 52.4 from a four-year low of 51.9 in November.

But Barclays Capital changed its forecast for interest rates, predicting that the Bank's Monetary Policy Committee would cut rates by a quarter point next week and then twice more this year. The cuts would take the benchmark rate to 4.75 per cent by the end of the year.

Sterling inter-bank borrowing rates continued to fall. The three-month Libor interest rate dropped to 5.785 per cent from 5.826 per cent the day before. The costs for banks borrowing from each other have been falling since the Bank of England and other central banks took co-ordinated action to inject liquidity into markets in the middle of last month.