World markets drop on bank credit fears

Stocks in the US and Europe dropped on concern about rising bank borrowing costs, a diminishing outlook for the global recovery and escalating tension between North and South Korea.

Investors were increasingly concerned about the impact of Europe's debt crisis on the global economy as a German government document showed that the country might widen its ban on speculative financial trades to cover all shares.

Heightened military tension in the Korean peninsula boosted corporate and sovereign credit-risk indicators to the highest level in 10 months. The gap between the cost to buy and sell corporate credit reached the widest in nine months as investors were wary of all but the safest government bonds.

"The market is trying to price in the worst-case scenario, of not only lending freezing, but of a major bank becoming insolvent," Art Hogan, chief market analyst at New York-based Jefferies Group Inc, told Bloomberg News.

In late trading, the Dow Jones Industrial Average dropped 0.94 per cent, the Standard & Poor's 500 Index lost 0.73 per cent. and the Nasdaq Composite declined 0.89 per cent.

Among the most active stocks were Bank of America, Citigroup, Exxon Mobil and Alcoa.

The Chicago Board Options Exchange Volatility Index, or VIX which is known as Wall Street's 'fear gauge', soared to more than 40 in morning trading. It was at 37.98 at 3.15pm.

The gauge has surged 84 per cent in May, which would be the biggest monthly increase since Lehman Brothers Holdings Inc's collapse in September 2008. It has closed at 40 or above 3.1 per cent of the time since 1990.

The benchmark Stoxx Europe 600 Index sank 2.5 per cent to 232.11, the lowest close since September. The U.K.'s FTSE 100 dropped 2.54 per cent, France 's CAC 40 declined 2.90 per cent. Germany's DAX slid 2.34 per cent.

Among the most actives were Banco Santander, Societe General, Prudential, BHP Billiton and Total.

The VStoxx Index, the benchmark gauge for European stock options, rose 6 per cent. The measure indicates the cost of protecting against declines in the Euro Stoxx 50 Index.

The London interbank offered rate, or Libor, for three-month dollar loans rose to 0.536 per cent, the most since July 7, according to data from the British Bankers' Association.

The dollar Libor-OIS spread, a gauge of banks' reluctance to lend, widened to the most since July 17.

The euro plunged to an 8-1/2-year low against the yen and neared a four-year trough versus the US dollar, on concern about global growth prospects.

"Increasingly, market participants are getting scared and fearful that we may have a repeat of late 2008," Camilla Sutton, senior currency strategist at Scotia Capital in Toronto, told Reuters.

In early afternoon New York trading, the euro was down 0.3 per cent at US$1.2322. The euro last week touched a four-year low of US$1.2143 on electronic trading platform EBS.

Sutton said she expected the euro to breach that four-year low, with US$1.18 the next key level.

Against the yen, the euro fell to around 108.85 yen, its lowest since late November 2001, according to EBS.

The Dollar Index, which measures the greenback against a basket of six major currencies, rose 0.54 per cent to 86.67.

Longer-term US Treasuries rose after the government sold US$42 billion of two-year notes at the lowest yield on record as concern Europe's debt crisis is spreading boosted the refuge appeal of US securities.

The Reuters/Jefferies CRB Index, which tracks 19 raw materials, declined 1.25 per cent to 248.83.

US crude was down US$1.80 at US$68.41 a barrel at noon in New York. Crude, down more than US$3 earlier, pared losses after the US consumer confidence index hit a two-year high in May.

ICE Brent crude was down US$1.87 at US$69.30 a barrel.

Hedge funds accelerated the oil price sell-off this month and oil was forecast to end the year close to US$75 a barrel, according to Credit Agricole CIB's global head of commodities and energy.

Spot gold was bid at US$1,198.90 an ounce at 1432 GMT, against US$1,190.05 late in New York.