Rate and oil fears spook markets

Share prices fell sharply around the world yesterday as the prospect of higher US interest rates and fears of the effects of $40-a-barrel oil prices sent shock waves through financial markets from Tokyo to New York.

A day of hefty markdowns saw £25bn wiped off the value of shares in London and New York's Dow Jones dip below the 10,000-point level in early trading.

Even a drop in oil prices triggered by calls from Saudi Arabia for the Opec cartel to pump more crude failed to stem the selling, which saw 5% falls in share prices in Japan, a 7% drop in Argentina and widespread declines across the European bourses.

John Snow, George Bush's treasury secretary, sought to reassure jittery markets by saying the US economy was on a "rising tide", but Wall Street was down 170 points in early dealing amid speculation that the Federal Reserve will raise interest rates next month from their 40-year low.

Analysts believe the year-long period of 1% interest rates in the world's largest economy is coming to an end following strong employment growth in the past two months.

Saudi oil minister Ali al-Naimi said an increase in output by the Opec was essential to balance global supply and demand after prices jumped to $40 a barrel on Friday on the back of fears about violence in the Middle East and rising demand in the US and China.

"We ... do not want to see prices rise to the level that they negatively affect the growth of the international economy or the demand for oil," he said. "It is apparent that demand, especially that of Asia, has and will continue to increase in the second half of this year."

He said the cartel should increase its production ceiling by 1.5 m barrels a day to 25m. Saudi Arabia produces a third of the Opec total.

US light crude prices tumbled $1.36 a barrel to $38.57 but experts said the drop might prove temporary unless there was a genuine increase in production.

"This is a move [Opec] have to make. We see demand for Opec's oil rising by 2m barrels a day in the third quarter and by another 2m barrels a day in the fourth quarter," said Gary Ross, chief executive of New York's Pira Energy consultancy.

In Japan, the Nikkei 225 index declined more than 500 points in frenzied trading because of higher oil prices, fears of economic slowdown in China and a security warning at the US mission in Tokyo.

The FTSE 100 index lost 103.2 points to 4,395.2, a decline of more than 2.3%. "The sharp rise in oil, although there are justifications, has taken investors by surprise," said Alex Scott, analyst at Seven Investment Management.

The dollar pushed higher against other leading currencies as the prospect of higher interest rates in the US increased the attraction to investors of holding the greenback. The dollar set an eight-month high against the yen of 113.58, gained 0.5% against the euro to $1.1825 and 0.7% against the pound to $1.775.

The dollar has gained 5.8% on the yen since the start of the year and entirely recouped a six-month decline begun after last September's call in Dubai from Group of Seven finance ministers for more flexibility in exchange rates.

"At the time of Dubai, the theme that was thrashed to death was that the US wanted and needed a weaker currency. Now all the talk is the US recovery and higher interest rates," said Ian Gunner, head of foreign exchange research at Mellon Bank.