London's markets in turmoil after Lehman collapse

London’s leading shares plunged to a three-year low today as markets endured a second day of turmoil in the aftermath of the Lehman Brothers collapse.

London’s leading shares plunged to a three-year low today as markets endured a second day of turmoil in the aftermath of the Lehman Brothers collapse.

The FTSE 100 Index fell 3.4% on top of a near-4% fall yesterday as investors continued to head for the exit.

Meanwhile, the Bank of England pumped £20bn (€25.25bn) into frozen money markets - following the £5bn (€8.9bn) injected yesterday – as banks fearing losses hiked inter-bank lending rates.

The move was echoed by the European Central Bank and the US Treasury amid hopes the US Federal Reserve could ease the pressure on banks with an interest rate cut later tonight.

The market bail-outs came as the rate at which banks lend to each other for three months rose to 5.791% – the biggest single-day jump since the crisis at US investment bank Bear Stearns in March.

The Footsie briefly fell below the 5,000 mark for the first time since June 2005 before recovering some ground later to close at 5025.6 points amid late session hopes of a US Government rescue for insurance giant AIG.

But the two days of losses – the worst for the index since July 2002 – have wiped a total of £93bn (€117.4) off the UK’s leading shares.

France’s CAC 40 and Germany’s Dax also registered falls after Asian stock markets slumped overnight. Hong Kong’s Hang Seng index was the biggest casualty, losing more than 5%.

AIG – massively exposed to the plunging US housing market – was granted a $20bn (€14.1bn) lifeline to shore up its finances last night.

But the giant, which sponsors Premier League champions Manchester United, has been downgraded by three major ratings agencies, making it more expensive for the firm to raise funds.

AIG, which made a net loss of $13.2bn (€9.33bn) in the first half of this year, saw its shares tumble more than 30% in early Wall Street trading.

With thousands of jobs facing the axe at Lehman Brothers, the tumultuous week has also seen investment bank Merrill Lynch seek a safe haven from the turbulence in a $50bn (€35.3bn) takeover by Bank of America.

In London, banking stocks were the main victims of the financial turmoil, with Halifax Bank of Scotland plunging 40% at one point because of concerns over higher funding costs in tighter money markets.

HBOS – which eventually closed 22% down – was also downgraded by a ratings agency, but sought to reassure worried investors.

“HBOS has a strong capital base and continues to fund very satisfactorily,” it said.

Other banking casualties included Royal Bank of Scotland, which has written off billions in losses on investments linked to the US housing market. The NatWest parent saw shares slump 10%.

Until the latest collapse, the blue-chip index had been propped up by miners and oil companies as commodity prices soar.

But as fears over global economic health grow, crude oil has now fallen from mid-July records of almost 150 dollars a barrel to just over 90 dollars - hitting market heavyweights such as BP and Royal Dutch Shell, which fell by 3% and 5% respectively.

Sentiment was also hit by Bank of England Governor Mervyn King’s letter to Chancellor Alistair Darling, which was issued after inflation hit 4.7% in August.

Analysts said the tone of the letter suggested interest rates may not be coming down as soon as some had previously hoped.

It also emerged that Mr King met Prime Minister Gordon Brown and Chancellor Alistair Darling this morning, although a Downing Street spokesman said it was “a routine and long-standing meeting” which had “been in the diary for some time”.

The Prime Minister’s spokesman said they discussed the “main economic and financial issues” facing the UK and the world.

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