Uncertainty about US bailout plan hits UK shares

The leading shares on the London Stock Exchange sank into the red today as investors took scant comfort from President Bush’s pledge to “rise to the occasion” with a banking rescue.

Uncertainty over prospects for a 700bn (€479.2bn) plan to take toxic bad debts away from banks weighed on the FTSE 100 Index throughout the day as traders awaited firm news of a deal.

The Footsie finally closed 2.1% lower at 5088.5 as the Bank of England joined central banks around the world in pumping billions extra into frozen money markets.

Stocks rose sharply yesterday on hopes of a deal but were hit today amid disappointment after talks in Washington broke up without agreement last night.

Us president Bush said the negotiations were “hard work” but added: “There are disagreements over aspects of the rescue plan but there is no disagreement that something substantial must be done...We are going to rise to the occasion.”

Wall Street’s Dow Jones Industrial Average picked up following the president’s comments but remained in negative territory.

The collapse of Washington Mutual – the largest US bank to fail so far - underlined the current fragility of the financial system as the fall-out from the US housing slump spreads around the globe.

The latest victim of the credit crunch has been bought by JP Morgan, the same company which also bought failed investment bank Bear Stearns in March.

In London, Lloyds TSB, Halifax Bank of Scotland and Royal Bank of Scotland were among the Footsie’s leading fallers, with Lloyds TSB the biggest victim, down 8%.

CMC Markets dealer Ian Griffiths said: “The big story continues to revolve around progress of the proposed bail-out for troubled financial institutions across the Atlantic and so long as a resolution here drags on, stocks seem set to find themselves continually under pressure.”

The worsening financial crisis meanwhile forced the Bank of England into an unprecedented intervention as it offered at least £40bn (€50.3bn) to cash-strapped banks.

Lenders are hiking mortgage costs because of a sudden surge in the rate at which banks lend to each other for three months, as those hit by the credit crunch hoard funds.

The Bank usually offers three-month money on a monthly basis, but will hold auctions every week from Monday for the first time while the pressures in wholesale markets remain.

The central bank has not revealed the sums involved in future auctions but they are likely to be of a similar size to Monday’s if desperate banks snap up the funds.

The move comes as interbank three-month lending rates soared to 6.28% yesterday - way above the Bank’s official 5% base rate.

This spread is now wider than at the time of Northern Rock’s emergency bail-out by the Bank of England just over a year ago, when the three-month rate was 1.15% above base rate.

The three-month rate is a key one for mortgage lending and today HSBC, Barclays’ lending arm the Woolwich, and internet and telephone bank first direct all said they were passing on recent increases in the cost of borrowing to customers.

Following the Bank’s move, three-month borrowing costs fell back, very slightly, to 6.26% as financial institutions still showed a reluctance to lend.

Investec Securities economist Philip Shaw said: “Credit market conditions are worrying. Today’s action takes place in the face of a further deterioration in capital market conditions, which have begun to look very scary.”

Central banks including the Bank of England also stepped up other efforts to ease the pressure in money markets.

The Bank lent $30bn (€20.5bn) for a one-week period, with another US$10bn (€6.8bn) being made available on an overnight basis.

It said the operations – mirrored by other central banks – were intended to ease funding pressure on banks at the end of the third quarter. Both were oversubscribed.

The injection extends last week’s initiative by the US Federal Reserve to use the Bank of England and the European Central Bank, as well as central banks in Switzerland, Japan and Canada, as conduits for dollar funds.

A statement said: “Central banks continue to work together closely and are prepared to take further steps as needed to address the ongoing pressures in funding markets.”

The US Federal Reserve has been pumping the money into overnight dollar markets after lending between banks fearful of losses virtually ground to a halt after last week’s financial turmoil.

In the wake of the Lehman Brothers bankruptcy and rescue takeovers of Merrill Lynch and Halifax Bank of Scotland, financial institutions have been gripped with fear.