Wall Street was gripped by a fresh financial panic tonight as fears spread that the Greek debt crisis will trigger a new catastrophe for the fragile global banking system.
Turbulent scenes in New York – reminiscent of the chaos around the fall of Lehman Brothers in September 2008 – followed a weak statement from the European Cental Bank that investors dismissed as a "do nothing" response to fears of wider contagion.
The blue-chip Dow Jones index briefly fell 900 points, or 9%, dipping below 10,000 points for the first time since early February, before halving its losses in the next 30 minutes.
The huge sell-off on Wall Street will cast a long shadow over the City, already nervous about the result of the general election. Shares in London – where trading closed before the mayhem in New York – had already fallen, with the FTSE 100 index finishing 81 points lower at 5261, making a near-10% decline since mid-April. Regardless of the outcome of the election, futures markets were flagging further big falls in share prices on Friday.
Currency markets were also rocked. The euro fell more than two cents against the dollar to $1.26. Sterling lost almost three cents to trade at $1.48.
The European Central Bank governor, Jean-Claude Trichet, said Spain and Portugal were "not Greece", and that the ECB governing council had not discussed injecting extra funds into the eurozone to boost demand and economic growth.
His comments, made as the Greek parliament passed a package of cuts in public services, failed to prevent the euro dropping to a 14-month low. Spain was also forced to pay sharply higher interest rates on its debt as investors appeared to dismiss the ECB's view that the eurozone was secure. Trichet said: "Greece and Portugal are not in the same boat and this is very visible when you look at the facts and the figures."
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Yet leading economists such as the Nobel prizewinner Joseph Stiglitz and Nouriel Roubini, who accurately predicted the credit crunch, have expressed doubts over the survival of the euro in the light of the ECB's rigid interpretation of its remit to maintain low inflation, regardless of the consequences of low growth and rising unemployment in countries forced to take deep cuts in public spending.
Roubini and Stiglitz are sceptical that governments can or should squeeze their spending to fit constraints laid down by the ECB and eurozone rules.
Professor David Blanchflower, the former Bank of England monetary policy committee member, said it was "crazy" for highly indebted countries such as Greece, Spain, Portugal and Britain to enter a "death spiral" of spending cuts that would lead to lower growth and more cuts. "All anyone is talking about is austerity, but all you get is more unemployment and low growth. Then you find yourself in a spiral of debt as low growth forces you to cut spending further," he said.
Analysts also said the ECB was closing its eyes to tensions in the single currency zone. "The ECB seems more concerned about cracks to its credibility than cracks to monetary union," said Christoph Rieger, co-head of fixed-income strategy at Commerzbank in Frankfurt. "This approach can be considered consistent with the ECB's principles. But it risks that the market will still force the ECB's hand before long."
Spain managed to raise €2.35bn (£2bn) in its latest government bond auction todayyesterday, but had to promise a yield of 3.58% – a fifth more than the rate it paid two months ago. Investors also pushed up the cost of insuring Spanish debt against default, despite assurances from the country's prime minister that it could meet promises to pay down debts.
The yield on Portugal's 10-year bond, which serves as an indicator of the risk of investing in the country's loans, increased by six basis points to 5.95%. "Investors are genuinely confused and concerned about the level and growth of sovereign indebtedness and what it means for the market," said Luke Spajic, head of European credit at Pimco, the world's largest bond investor. "It's not that the market is testing one country – it's very anxious about the sustainability of debt in general."