US shares suffer sixth biggest fall in history as panic grows

A trader in Tokyo reacts on a stressful day for markets around the world (AFP/Getty)

In the first trading since the decision by the Standard & Poor's ratings agency to strip the US of its AAA credit rating, shares on Wall Street recorded one of their worst one-day falls ever.

Last night the Dow Jones Industrial Average closed down 635 points – 5.6 per cent – at 10,810 after a day of relentless selling. The index has fallen by more points on only five occasions.

In London, the FTSE-100 index ended lower for the seventh day in a row, and has now lost over 800 points, or 13.7 per cent. By contrast gold, a traditional safe haven in troubled times, hit yet another all-time high, at over $1,700 an ounce. London shares are at their lowest since July 2010, just after George Osborne's emergency Budget.

Investors have been especially spooked by remarks from David Beers, head of sovereign credit ratings at Standard & Poor's, who said: "We don't anticipate a scenario at the moment in which the US would quickly return to AAA."

More bad news came from the Organisation for Economic Co-operation and Development, the club comprising the advanced economies, which warned of a further slowdown in the global economy. It said that growth rates in the US, Japan and Russia have peaked, while Britain, the eurozone and others are in a "continued slowdown".

The OECD's "leading indicator" for the UK – a signal about how the economy might progress over the next six months – fell for the sixth month in a row, and at an increased rate in June with the suggestion that the economy will continue to flatline until next spring.

The Bank of England is due to reveal its latest forecasts for inflation and growth tomorrow. It is expected to follow the Office for Budget Responsibility in admitting that its projections have not been borne out by reality.

The rout began in Asia: the main stock index fell almost 4 per cent in South Korea and more than 2 per cent in Japan. European markets opened later and fell too, with Germany down 3 per cent and France 2.5 per cent.

However, the European Central Bank's policy of buying Spanish and Italian government bonds to take the cost to Madrid and Rome of financing their public sectors back to manageable proportions seems to be working.

In contrast to their damning assessment of US political gridlock, S&P's officials had kind words to say about the UK and France's AAA ratings. Mr Beers said he expected the UK Coalition to hold together until the next election and to implement its austerity plans with only minimal changes. The agency moved its outlook on the UK's AAA rating from negative back to stable last October.

And John Chambers, who chairs the sovereign debt committee at S&P's, praised France for a "well-designed fiscal policy" – in particular plans to raise the retirement age to cut the country's long-term pension burden. "The government got a lot of pressure from the street, but it didn't cave in to that pressure, and that underscored its credibility," Mr Chambers said.

Nonetheless, on one measure, the cost of insuring government bonds against default, the markets havealready downgraded France – hergovernment bonds are more costlyto insure against wipe-out than those issued by the Malays, Thais, orMexicans.

A minority of analysts are starting to argue that the UK could be vulnerable because of its poor growth prospects. Economists at UBS Bank commented: "The UK's AAA sovereign rating is vulnerable if the economy continues to disappoint on growth and the political response is seen to waver from a stringent fiscal consolidation plan. The key risk here is the impact of the downgrade on US economic growth and any spillover impact on Spain, Italy and France. On the political front, there is reason to be somewhat more comfortable. All in all, the fear in the UK is not so much about errors from policymakers, but rather, on the potency of the tools available to policymakers to address the crisis."

The current riots in London may also dent market confidence in the will of the Coalition to implement its programme of spending cuts in the face of social unrest.

Who's next for a debt downgrade?

Italy (A+)

Italy has her current borrowings well under control, indeed on some measures she is actually enjoying a budget surplus. However her accumulated national debt is some 120 per cent of GDP, way beyond what most economists regard as sustainable. Long-standing issues of competitiveness and an ageing population add to the fiscal challenge.

Spain (AA)

On most measures her public finances are healthier than Britain's, but Spain suffers from structural economic problems, including high unemployment and a broken real-estate and banking sector.

France (AAA)

France's diversified economy helped her to avoid the worst of the recession and she is politically stable. However doubts are creeping in about her ability to withstand a "contagion" effect if Spain and Italy find themselves in further difficulties. Doubts have surfaced about President Sarkozy's ability to maintain the pressure on public spending in an election year.

UK (AAA)

The UK has never reneged on its debts, though England did in the reign of Charles II. There is a first time for everything, though, and the threat to the UK would rise if growth remained stagnant and the Government's deficit reduction plan became unworkable. Such a loss of credibility could see a downgrade. Some economists are already arguing that the Chancellor will miss his debt reduction targets. The riots may mean social unrest becomes a factor in investors' minds.

Germany (AAA)

If Germany carries on accumulating other nations' debts, then her own ability to carry such burdens may come into question. Yields on "bunds" have edged up in recent months, reflecting this long-term and still remote risk.