Persistent worries about tight credit conditions prompted a fresh burst of risk aversion in financial markets on Monday.

Equity markets suffered moderate losses after the strong gains of last week, while the yen rallied as investors unwound risky carry trades, where low-yielding currencies are sold to fund purchases of higher-yielding assets.

Concerns about money market stress kept to the fore as the one-month sterling Libor rate was set at 6.715 per cent – up more than 62 basis points from Friday and the highest level for nine years – reflecting year-end demand and mirroring sharp spikes in the euro and dollar one-month rates last week.

But Joachim Fels, chief global fixed-income economist at Morgan Stanley, warned there might be more behind the funding pressures in interbank markets than mere seasonal factors.

“The fundamental issue is that banks’ balance sheets are under severe stress, due to writedowns on subprime assets and due to the ‘repat-riation’ of off-balance-sheet assets with dubious value,” Mr Fels said.

“This not only makes banks scramble for liquidity and unwilling to lend to counterparties, but also it makes them less willing and able to extend fresh credit to households and companies.”

Those worries were highlighted by Joaquin Almunia, the European Commission’s economic and monetary affairs commissioner on Monday. “Tighter credit conditions imply fewer borrowing opportunities,” he said. “This has raised the prospect of slower economic growth in the coming years.”

Credit concerns helped fuel safe-haven buying of government bonds, and a drop in US manufacturing employment. The yield on the two-year US Treasury was down 12 basis points at 2.89 per cent, while the 10-year yield was 7bp lower at 3.87 per cent. In Europe, the 10-year Bund yield fell 7bp to 4.09 per cent, while the Japanese 10-year yield slipped 2bp to 1.45 per cent.

The US Institute for Supply Management’s manufacturing business index fell to 50.8 in November from 50.9 the previous month. While the headline ISM met expectations, the employment index fell below 50, indiacting a contraction in activity. Bond traders said the November payroll report due on Friday, may be much weaker than a forecast rise of 70,000 jobs.

“Manufacturing has slowed substantially but is not so weak that recession is imminent,” said Ian Shepherdson, chief US economist at High Frequency Economics.

Meanwhile, manufacturing data in the eurozone and the UK provided some interest ahead of European Central Bank and Bank of England policy meetings this week.

The eurozone purchasing managers’ index showed a final reading of 52.8 in November, up from 51.5 in October. Other data showed that the unemployment rate fell to 7.2 per cent in November from 7.3 per cent – the lowest level since the eurozone was formed in 1999.

The figures did little to alter expectations that the ECB would leave interest rates on hold on Thursday.

But recent speculation that the Bank of England might cut rates this week were knocked by an unexpected rise in the UK manufacturing PMI to 54.4 from a downwardly revised 52.8.

“Given that most monetary policy committee members want to wait for more hard evidence of a slowdown before cutting rates, the report reduces the chances of a move on Thursday,” said Nick Kounis, senior economist at Fortis.

Equity markets endured a relatively sluggish session and in New York, the S&P 500 index closed down 0.6 per cent while the Eurofirst 300 index broke a three-session run to close 0.4 per cent lower. Most Asian stock markets retreated, with the Nikkei 225 in Tokyo shedding 0.3 per cent.

On the currency markets, the yen bounced off a two-week low against the dollar and gained ground against the euro. Last week’s rally in the dollar ran out of steam amid expectations that US interest rates would be cut next week.

In commodities, oil slipped to a five-week low at one point in the day, affecting the chances that Opec, the oil producers’ cartel, would agree to output increases at its meeting in Abu Dhabi this week, analysts said. However, January West Texas Intermediate, the US benchmark, ended the day 60 cents higher at $89.31.

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