Markets around the world tumbled yesterday and the FTSE 100 hit an eight-month low over fears the debt contagion was set to engulf Spain.
Shares nosedived as talk emerged that Spain would have to step in to salvage more banks after it bailed out the small savings bank CajaSur on Saturday. Tensions between North and South Korea also knocked the markets.
Peter Dixon, an economist at Commerzbank, said: "There is panic out there. The bad news has been picked up and magnified."
He continued: "The concern is over the stability of the Spanish banking sector, as well as the wider lack of financial leadership in the eurozone countries. The situation in Korea hasn't helped."
The Bank of Spain took control of the savings bank CajaSur at the weekend after its merger with a rival failed.
The Credit Suisse analyst Santiago Lopez said: "The intervention is quite negative news for the financial system, for the sovereign risk profile and for the economy in general." Spain's Ibex 35 fell 3.1 per cent yesterday.
Standard & Poor's downgraded Spain's sovereign debt rating last month shortly after it had done the same to Portugal and Greece.
Market concern rose further on Monday when the International Monetary Fund warned that Spain faced "severe challenges". This included a "dysfunctional" labour market, large fiscal deficit, weak competition, falling property prices and "a banking sector with pockets of weakness".
Markets fell across the world from South Africa and Moscow to China and India. The Shanghai market fell almost 2 per cent as the government looked set to step in and curb property prices.
The UK's blue-chip stocks suffered, with the FTSE 100 falling through the 5,000 point mark for the first time since October. It was 1.17 per cent lower at 4,988.7 points, on track for its fourth worst monthly performance ever. The banking stocks suffered particularly badly, with Lloyds Banking Group the worst, down almost 9 per cent at 50.52p.
The jitters over contagion, as well as the austerity measures introduced in the UK this week, hit sterling, which fell more than 1 per cent against the dollar. The euro fell to a near four-year low against the dollar and an eight-year low against the yen.
Germany's finance ministry, meanwhile, moved to head off further market turmoil by drawing up plans to extend its ban on naked short selling. A document leaked from the finance ministry outlined a plan to extend the ban, which currently covers its 10 most important financial companies and some credit default swaps, to all German companies listed on its domestic exchanges.
Germany banned naked short selling – which involves selling securities that the trader does not own, and has not borrowed – in a surprise move last week. The announcement, and Chancellor Angela Merkel's comments saying the euro was in danger, sent the markets lower.
The New York Stock Exchange also moved to avoid market turmoil, implementing Rule 48 for the third time this month. As the exchange's futures suggested a huge sell-off in the market, NYSE officials called in the rule to suspend the need for market-makers to show pre-opening indications when the market is particularly volatile. The Dow Jones still fell 1.79 per cent in the morning, but recovered to end only 22.82 points down at 10043.75.