(CORRECTED) WRAPUP 1-Market rout drives global economy to precipice

Tue Aug 9, 2011 4:44am EDT

(Clarifies title of Spanish prime minister)

* Fear grips Asian markets after Wall Street plunge

* China inflation above expectations, headache for central bank

* Obama says S&P action adds urgency to deficit cutting

* Pressure mounts on Fed to stimulate U.S. economy

* S&P index plunges 6.6 pct, worst since Dec. 1 2008

By Koh Gui Qing and John Chalmers

BEIJING/SINGAPORE, Aug 9 (Reuters) - The global economy edged closer to calamity as stock markets slumped further in Asia on Tuesday, with investors losing confidence that the United States and Europe can rein in their debt burdens quickly and avert a double-dip recession.

The worsening market trauma has piled pressure on the U.S. Federal Reserve to announce fresh measures of support for the U.S. economy at a policy meeting on Tuesday, but analysts said its options were limited.

"The current situation could be seen as a fast, complete and unexpected loss of confidence that has been building up over the past few weeks," BNP Paribas said in a note published as Asian stock markets swooned, losing between two and seven percent.

"Given that the global economic recovery remains fragile, this fast disappearance of confidence is worrying, which puts us back in a vicious circle where the market drop feeds pessimism."

As of Monday, stock losses had wiped more than $3.8 trillion from investor wealth globally over eight days and sent investors rushing for safety in the Swiss franc, the Japanese yen and gold.

CHINA INFLATION DASHES STIMULUS HOPES

As the flight from risk continued in Asia on Tuesday, there was more bad news, this time from China, the stuttering global economy's main engine room.

Official data showed China's annual inflation rate quickening to 6.5 percent in July, putting the country's central bank in a bind as it tries to keep prices in check without dragging down an economy facing increasing threats from abroad.

With inflation at that level, China may not be in a position to reprise its 2008 role of lifting the global economy, although some analysts called on Beijing to act.

When the Lehman Brothers bankruptcy triggered a worldwide slump, China implemented a stimulus package that helped buffer its own economy and buoy the world.

"It's time for Beijing to announce to the whole world that it will try to stimulate domestic demand again," said Tang Yunfei, an analyst with Founder Securities in Beijing.

Global leaders failed to reverse sliding markets on Monday after the blow dealt to investor confidence by Standard and Poor's downgrade of the U.S. sovereign credit rating.

The downgrade heightened concerns that the twin-pronged crisis of a worsening euro-zone debt crisis and a faltering U.S. economy raised the risks of a double-dip recession.

The European Central Bank (ECB) swept into the bond market to buy up Italian and Spanish debt and sling a safety net under the euro zone's third- and fourth-largest economies. But bickering persisted in Europe over a longer-term rescue plan.

In the United States, President Barack Obama called for urgent action on the U.S. budget deficit, but his proposal on taxes was promptly rebuffed by Republicans.

A pledge by G7 finance ministers and central banks on Sunday to provide extra cash if markets seize up also provided little solace as the authorities' credibility wore thin.

"Four years into the financial crisis, it is becoming increasingly clear that the biggest deficit is not in credit, but credibility," Harvard University economist Kenneth Rogoff wrote in the Financial Times.

"Markets can adjust to a downgrade of global growth, but they cannot cope with a spiralling loss of confidence in leadership and a growing sense that policymakers are disconnected from reality."

MARKETS "PRICING FOR A CRISIS"

In the United States the broad Standard and Poor's 500 index plunged 6.7 percent to close at 1,119.46 on Monday, its worst sell-off since Dec. 1, 2008. The Dow Jones shed 634.76 points to 10,809.85.

Particularly worrisome was a more than 20 percent plunge in the shares of Bank of America , the largest U.S. bank. AIG sued it for $10 billion for allegedly deceiving investors, on top of mounting concerns about the size of its potential losses from mortgages litigation and questions about management.

In Asia concern mounted that the region would inevitably feel the cold wind of the West's slowdown.

Japan's Nikkei share average fell 3.2 percent and MSCI's broadest index of Asia Pacific shares outside Japan shed 4.1 percent, taking its losses over six trading days to 18.5 percent.

South Korea's KOSPI slid 9 percent at one stage. A stock exchange official in Seoul said the bourse may ban short selling of shares to stabilise markets.

"The speed and degree of deterioration in the situation is akin to what we saw during the failure of Lehman Bros, through the dot.com burst ... and during the 1982 recession," said Warren Hogan, chief economist at ANZ Banking Corp in Australia.

"We are looking at markets pricing for some sort of financial crisis. I think we are at a critical period now."

ECB TO THE RESCUE

On the political front, Obama said he hoped the loss of the prized AAA credit rating would add urgency to U.S. budget cutting plans.

Standard and Poor's cut the ratings of credits tied to U.S. sovereign debt to AA-plus, namely government mortgage agencies, clearing houses and insurers. The Treasury market soared on Monday despite the downgrade as investors fled stocks.

Obama called for both tax hikes and cuts to welfare programmes as part of the $1.5 trillion in deficit reduction that a special committee would deliver in late November. But Republican House Speaker John Boehner once again rejected the call, saying tax hikes were "simply the wrong approach."

Obama also spoke with Italian Prime Minister Silvio Berlusconi and Spanish Prime Minister Jose Luis Rodriguez Zapatero, welcoming measures by their governments to address the economic turmoil in Europe.

Traders estimated the ECB bought about 2 billion euros in Italian and Spanish debt after it agreed on Sunday to broaden its bond-buying program for the first time to halt an attack on the Mediterranean countries. . Italian and Spanish yields declined sharply.

The ECB move was seen as only a temporary solution however, due to the sheer size of Italy's bond market -- $1.6 trillion -- and there are doubts in the market it can be sustained.

"What the market is demanding is the assurance either from Europe or the G7 or the G20 that ... there will be someone who can lend to Italy and Spain," said Takuji Okubo, chief economist for Japan at Societe Generale. (Editing by Dean Yates)

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