Stock markets and dollar plunge again on fears over bank crisis

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The rescue of Bear Stearns rocked markets that had barely recovered from the shock of Thursday's news about the state of the American economy, particularly high home repossession rates, which virtually confirmed that the US is entering a recession. As with the problems at one of Carlyle Group's funds, and the rescue of Countrywide by Bank of America, the problems at Bear Stearns further eroded confidence in the US financial system.

Neil MacKinnon, chief economist at the ECU hedge fund, said: "We are facing a potential black hole for all financial markets. This is being labelled as perhaps the worst financial and banking crisis since the Great Depression. While that sounds fairly apocalyptic, I think it is a realistic assessment of what is happening at the moment."

The result was to send shares sharply lower, and for the dollar to hit new depths against other currencies. The euro traded at an all-time high of $1.5657 against the US currency, the yen hit a 12-year high, while sterling rose above $2.03 before closing at $2.02. Fears that the dollar's precipitate decline could turn into a rout led to speculation that the G7 may intervene to support the dollar. Bear Stearns lost half of its value within 30 minutes of the market opening, and closed down 47 per cent. The Dow Jones ended down almost 2 per cent at 11,951.1; the FTSE 100 closed down 60.7 points at 5,631.7.

Oil and gold hit new highs. Investors also fled to the comparative safety of US Treasury bonds, pushing shorter-term yields to their lowest since 2003.

All eyes are on the Federal Reserve's interest rate decision on Tuesday. Yesterday, the Fed's chairman Ben Bernanke pledged to help homeowners, suggesting that lower rates would help those 1.5 million Americans due to reset the rates on their mortgages this year. He added that he was "strongly committed to fully employing our authority, expertise and resources to help alleviate their distress".

There is a near unanimous expectation that the Fed will cut a further 0.75 percentage points, on top of the 1.25 percentage points of cuts made in January. Rates stand at 3 per cent. Encouraging news on US inflation will give the Fed wider room for manoeuvre. The US Department of Labour reported that the consumer price index was unchanged in February, having risen 0.4 per cent in January, a surprisingly good result. There was even talk of a full 1 percentage point cut, which would be a truly dramatic move.

Even if the Fed does cut rates by 1 percentage point, it looks to be too late to prevent the US economy's slide into shrinkage. In the last quarter of 2007, it grew by only 0.6 per cent on an annualised basis, against 4.9 per cent in the third quarter. With rates at or close to 2 per cent, the Fed will soon have very few shots left in its locker, though it will be helped by the Federal Government's planned $156bn boost to the economy.