Eastern Europe triggers rush for safety

Fears of banking turmoil in eastern Europe caused global investors to rush for safety on Tuesday, with warnings about European financial institutions provoking a stampede into the dollar and US bonds.

The turmoil was prompted by a report from Moody’s, the credit rating agency, which warned that west European banks with east European subsidiaries were at risk of downgrades. Standard & Poor’s, a Moody’s rival, later issued a similar caution.

The euro fell 1.5 per cent to a two-month low against the US dollar, sinking below $1.26 for the first time since December, and also dropped sharply against the pound and the yen, while the Polish zloty hit a five-year low against the euro. The general flight away from risky assets also hurt US stocks. Bonds rallied as investors put money into the relative safety of government debt.

The S&P 500 fell 4.6 per cent to its lowest level of the year. Bank stocks led the market lower, with Wells Fargo falling 13 per cent and JPMorgan Chase losing 12 per cent. US Treasury prices rose, with the yield on the 10-year note falling 25 basis points to 2.64 per cent.

The news came as Barack Obama, US president, signed into law the $787bn stimulus bill designed to pump demand into the US economy through tax cuts and spending increases.

“The safety trade continues, and there are very few places to hide,” said Tobias Levkovich, chief US equity strategist at Citigroup. “There are still many concerns in the market, from the disappointment with [Treasury secretary] Tim Geithner’s financial rescue plan to further poor economic data from Japan and Europe to worries about banking industry exposure to Eastern Europe to concerns about US automakers.”

Several Eastern European countries have been hit by the rapid withdrawal of foreign capital and have struggled to fund yawning current account deficits and prevent runs on their banking systems.

“This is reminiscent of the Asian crisis of 1998,” said Michael Wang, an emerging market strategist at Morgan Stanley. “We are seeing what used to happen in emerging markets, where during the years of global expansion countries borrowed heavily and built up large external imbalances, only to face downward pressure on currencies and growth once the cycle turned and foreign capital inflows dried up.”

Polish and Czech shares dropped to their lowest level in five years, while other markets in the region came under pressure. In Moscow, equity trading was temporarily suspended amid sharp price drops, provoked partly by the government cutting its 2009 economic forecast from a contraction of 0.2 per cent to one of 2.2 per cent.

Figures on Tuesday showed that foreign investors continued to pour money into the US in December, as demand for relatively safe financial assets outweighed concern about the deepening downturn in the American economy.

Foreign purchases of US securities grew to $74bn in December, up from $61.3bn the month before.

Additional reporting by Alan Rappeport in New York