Shares dive on interest rate fears

Britain's leading shares suffered their biggest one-day fall in more than three and a half years yesterday, as global stock markets were battered by news of rising inflation in the US and Europe and expectations that interest rates would rise around the world.

Markets in stocks, bonds, currencies and metals have suffered intense volatility in recent days as dealers worried that growing signs of inflation, particularly in metal and oil prices, would provoke central banks to raise interest rates, hitting firms' profits. The FTSE 100 index finished a frantic day almost 3% lower, off 170 points at 5,675.5. This was the worst points fall since September 2002 and the largest percentage fall since March 2003. The index is now 7.5% down from last month's six-year high of 6,132.

The market was unnerved early in the day by news that a member of the Bank of England's monetary policy committee had voted for an interest rate rise this month. It is the first time in a year that a member has backed a rise in rates and the markets took it as a sign the Bank may raise borrowing costs from 4.5% later this year.

European markets also suffered their biggest losses in almost three years after data for the eurozone showed inflation rose faster than expected to 2.4% in April. The European Central Bank is now likely to raise interest rates next month.

But the biggest shock of the day came from American figures showing that rising gasoline prices - now more than $3 a gallon (about 35p a litre) - had pushed US inflation up sharply last month. That sent the Dow Jones down sharply as dealers feared that the Federal Reserve, the US central bank, would continue raising interest rates from their current 5% level.

That, though, was sufficient to spark a rise in the dollar which has fallen sharply in recent weeks because of worries over the country's enormous trade deficit.

Ian Kernohan, an economist at Royal London Asset Management, said: "Today's US inflation data has caused the markets to worry that the Fed are behind the curve and that inflation is out of the gate, but with US growth set to slow, inflation concerns should wane."