Rally fizzles out as London leads slide in markets and Dow falls to four-year low

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Huge falls again for Dow and FTSE

Johnston & Johnston adds to Wall Street's woes

The rally on world stock markets fizzled out in dramatic fashion yesterday as London led a slide in share prices with a 4.6 per cent fall and American markets fell to levels not seen for several years. The Dow Jones fell to a level last seen in 1998.

The FTSE 100 slumped 199 points to 4,098.3 as gloomy corporate news on Wall Street derailed the recovery. The fall halted a three-day bounce that had lifted the index away from Tuesday's six-year low of 3,860.

"It's pretty bad when the market can't even sustain a three-day rally," said an economist at a City brokerage.

Shares fell in London from the start of trading as the City picked up Wall Street's gloomy mood on Thursday evening. But the falls, which had hit 120 points by midday, accelerated quickly as the New York markets suffered fresh falls. The Dow tumbled 390.23 points, or 4.6 per cent, to 8,019.26, a level last seen in October 1998. The S&P 500 index lost 33.30, or 3.8 per cent, to close at 848.26 while the Nasdaq lost 37.88 to close at 1,319.07 points, both the lowest levels since October 1997.

Sheetal Radia, a senior economist at Standard & Poor's MMS in London, said US and UK markets could be heading back to 1995 levels, which would put the FTSE 100 at just 3,000 ­ a further 28 per cent drop. He said much of the rise during the post-1995 boom was linked to claims for an "economic paradigm" but now it looked based on exaggerated earnings figures. "It is like coming home and finding that you can't trust your parents any more," he said. "The markets need to return to levels that prevailed prior to the heady times."

In the US, Will Muggia, manager of the Touchstone Emerging Growth Fund, said: "The outlook is still not good. Earnings may have bottomed, but there's no palpable sign of an uptick yet. Investors are waiting for capital spending and information technology spending to increase and they haven't seen it."

This mood of scepticism over company profits was highlighted by news of a criminal inquiry into the drugs giant Johnson & Johnson. The investigation relates to alleged record-keeping irregularities. Mr Radia added that the market was also undergoing a structural shift to a new era of low inflation and weak corporate pricing power.

Official figures yesterday showed US inflation was almost non-existent in June, as price softness could be seen in everything from clothing and new cars to housing. The consumer price index rose just 0.1 per cent last month, after no changein May.

This took the annual inflation rate back down to 1.1 per cent, its lowest rate for 16 years. Paul Ashworth, international economist at Capital Economics, said: "There is nothing on the inflation horizon to really worry the Federal Reserve and, while uncertainty continues to surround the recovery, rates will remain on hold for a good while yet."

The stock market sell-off pushed the dollar to new lows as investors looked for alternative havens. The dollar fell to $1.019 against the euro, its lowest level since January 2000. The fall was also helped by trade figures showing that America's deficit with the rest of the world set a record in May for the second straight month. The trade gap widened to $37.64bn from April's $36.14bn and overshot analysts' forecasts for a $35.23bn deficit.

Swiss stocks fell almost 6 per cent to a five-year low while the French and Spanish markets dropped about 5 per cent.