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Global markets on 'cliff edge' amid fears over European banks

• Value of top 100 UK firms fell by £100bn in six days 

• US consumer confidence lowest for seven months

• Jill Treanor and Nick Fletcher
• guardian.co.uk, Tuesday 29 June 2010 20.50 BST
• Article history

There are concerns over a crucial repayment on a €442m ECB loan to European banks which is due on Thursday. Photograph AP/Getty Images

Fears that government austerity packages will hinder global growth have combined with fresh anxiety about the health of European banks to hammer investor confidence.

Shares on both sides of the Atlantic dropped heavily amid warnings that markets were on a "cliff edge".

In jittery trading ahead of a crucial repayment by Europe's banks of a €442bn (£362bn) European Central Bank loan on Thursday the rates at which banks lend to each other in euros rose to their highest levels in eight months as rumours swirled that some banks were finding it difficult to raise funds in the money markets.

The FTSE 100 has now fallen 14% since its April peak after losing 157.46 points to close at 4914.22, a 3% decline on the day and its lowest level since September last year. French and German markets lost about 3%. Wall Street was down 235 points by the time London closed, about 100 points below the 10,000 level.

Analysts will be looking tomorrowfor an indication of whether banks are becoming less reliant on their taxpayer lifeline when the ECB offers a way to refinance the €442bn one-year loan hours before the repayment is due.

If banks ask for more than €300bn to repay their existing loans with the more expensive three-month money being provided by the ECB, then concerns about the health of the banking system will escalate, analysts said.

Spanish finance minister Elena Salgado added to anxiety about the loan repayment by urging the central bank to heed the problems facing some Spanish banks. "The ECB says it doesn't like governments to tell it what to do. I simply say I hope that on this occasion, as in others, the ECB will be aware of the needs of the Spanish financial system," she told Spanish radio.

The publication of European-wide stress tests on major banks in a fortnight was also adding to the nerves while a bigger than expected fall in consumer confidence in the US prompted a debate about whether economies were heading for a double-dip recession. Oil prices fell 3% and the Baltic dry freight index, which measures demand, fell to its lowest level for nine months.

Robert Talbut, chief investment officer at Royal London Asset Management, said: "The European banks' funding issue is a real issue and it is coming to a head in part because the ECB is trying to withdraw some longer term facilities. A number of European banks, it is rumoured, are struggling to get funding in the wholesale markets and that is evoking memories of the dog days of 2008/9. Simultaneously it's unhelpful that [the economic] data is sending more mixed messages leading to more questions on the durability of the recovery".

Today's fall means that in the past six trading days the FTSE 100 has lost about 380 points, wiping almost £100bn off the value of Britain's top companies.

Worries that European austerity measures would hamper recovery were augmented by signs that the Chinese economy – which economists hoped would take up some of the slack – was also cooling off while the fall in the widely followed confidence index in the US, to its worst level for seven months, comes ahead of important non-farm payroll figures on Friday – a gauge of the strength of the US jobs market. Investors were seeking safety as rates fell in the US bond market. The yield on the 10-year note dropped to 2.97%, the first time it has fallen below 3% since April 2009.

Analysts at Royal Bank of Scotland were urging clients to position themselves for a economic downturn. "We strongly believe that a cliff-edge may be around the corner, for the global banking system, particularly in Europe, and for the global economy, particularly in the US and Europe" said Andrew Roberts, head of European rates strategy at RBS.

Nick Parsons, head of UK and European research at National Australia Bank, said the scene was being set for a "bout of great nervousness". "It is inconceivable that tests on 100 banks can be published with the conclusion that all one hundred are fundamentally robust unless the assumptions behind the tests are relaxed to the point of nonsensical," Parsons said.

Amid the market anxiety, the UK pulled off its largest ever offering of government debt through a syndicate prompting Robert Stheeman, chief executive of the Debt Management Office, to insist there the market for gilts remained attractive.