Fears of ‘Lehman-style event’ loom large

FEARS over the health of the US economy and eurozone delivered a devastating two-pronged attack on investor confidence this week.

Weak economic data in the US added to fears that the country could plunge back into recession, while Spain and Italy moved closer to failing to pay their debts. A drop in consumer spending and manufacturing orders in America came as traders digested the potential impact of vast spending cuts, drawn up as a part of a deal to lift the country’s debt limit.

Meanwhile, escalating bond yields in Spain and Italy — seen as a sign of plummeting confidence in a country’s finances — lifted the likelihood that both countries would follow in the footsteps of Greece and Ireland and require a multi-billion bailout from the EU.

Michael Hewson, analyst at CMC Markets, said the current rout pointed towards a “Lehman-style event” — alluding to the catastrophic collapse of the US bank at the height of the financial crisis.

He said: “The key causes of the rout are concerns about the slow growth in the US, following last week’s GDP figures and manufacturing figures.

“Then there’s also fears over the eurozone debt crisis, particularly with Italy being the third biggest economy in the eurozone. If the crisis causes a choke-up in credit, we may see a repeat of the credit crisis and banks will stop lending to each other.”

The most recent developments in the US and eurozone add to a climate of general economic malaise across the world.

British banks have this week laid bare their exposure to the debt-laden eurozone as they revealed losses directly linked to their assets in Greece and Ireland. The US Commerce Department last week revealed its economy grew at an annualised rate of 1.3% in the second quarter, much lower than the 1.8% forecast by economists. In a surprise development, first-quarter growth was revised down sharply from 1.9% to 0.4%.

The debt crisis in the eurozone has been the source of market volatility for months, with the focus now shifting from peripheral economies, such as Greece and Portugal, to core leaders, such as Spain and Italy.

With yields on Spanish and Italian bonds remaining at more than 6% — just shy of the 7% level which triggered bailouts for Greece, Ireland and Portugal — European Commission president Jose Manuel Barroso called for leaders to act.

And the bad data continued as figures showed Italy’s economy grew at a paltry 0.3% in the second quarter, providing further evidence that the recovery is running out of steam.