Shares slump on European bank fears

[Guest guest]

http://news.bbc.co.uk/2/hi/business/10444577.stm

Shares slump on European bank fears

Page last updated at 16:02 GMT, Tuesday, 29 June 2010 17:02 UK

Global stock markets have fallen sharply on renewed concerns over the European

banking sector.

Investors are apprehensive ahead of a deadline this week for banks to repay

loans taken out a year ago at low interest rates.

As a result, leading European share indexes slumped about 3%, while US stocks

fell more than 2% in morning trading.

The concerns also pushed the pound to a new 19-month high against the euro.

The pound rose almost half a cent to 1.2389 euros, its highest level since the

immediate aftermath of the financial crisis in November 2008.

Stock markets were hit hard, with the UK's FTSE 100 slipping 2.7%, France's Cac

40 losing 3.6% and Germany's Dax falling 3.1%.

'Growing fear'

The European Central Bank (ECB) will offer funds on Wednesday to banks looking

to repay 442bn euros worth of loans later this week.

" Markets are tense going into the end of the long-term refinancing programme,

along with [Wednesday's] three-month auction, " said Hydeskov, senior

currency analyst at Danske.

Last summer, the ECB was forced to offer European banks cheap 12-month loans to

help them through the financial crisis. This was a longer repayment term than

the usual three to six months.

But the ECB has said it will not offer 12-month loans this time around, raising

fears that European banks may again face funding difficulties.

And as Jane Foley, research director at Forex.com, points out, the rate at which

banks lend to each other has more than doubled in recent months.

So with heightened concerns about which banks still have bad loans on their

books, there is a growing fear among investors about the health of the European

banking sector.

" Tension in the banking sector is running high and the euro will remain under

significant pressure [as a result], " says Ms Foley.

And little is likely to change until the results of European bank stress tests,

which should reveal the extent of bad loans on their books, are released in

September, she adds.

Duncan Higgins, currency market analyst at Caxton FX, agrees: " The pound is

still undervalued and has further to appreciate [over the summer]. "

Inflation concerns

But it is not just a weak euro that is boosting the pound.

Fears among credit ratings agencies and investors about the UK's burgeoning

budget deficit have been allayed by last week's Budget, in which the new

coalition government announced stringent measures to cut spending and increase

taxes to reduce debt levels.

Sterling has also benefited from comments made by Bank of England Monetary

Policy Committee (MPC) member Sentance on Monday, in which he said the UK

would need to start raising interest rates soon.

Mr Sentance voted to raise rates at an MPC meeting earlier this month.

Analysts said that if inflation remains well above the Bank's 2% target rate,

the pressure to raise rates will increase.

Inflation, as measured by the Consumer Prices Index, currently stands at 3.4%.

" If inflation expectations show further signs of rising, and if nominal demand

remains robust, we think the MPC will become increasingly uncomfortable with the

current loose policy setting, " said Barclays Capital.

Higher interest rates make sterling a more attractive investment and tend,

therefore, to increase its value.