Bank agony, money squeeze batter stocks, dollar

By Jeremy Gaunt, European Investment Correspondent

LONDON (Reuters) - Global stocks fell sharply and the dollar tumbled on Monday as a fire sale of Bear Stearns and an emergency Federal Reserve cut of a key lending rate sparked fears that a worldwide credit crisis will claim more casualties.

Traders reported that money markets were near standstill with banks increasingly wary of lending to each other.

European shares sank nearly 3.5 percent, following a sell-off in Asia where Japan's leading indexes shed 3.7 percent. Wall Street looked set for a sharply downward open.

The dollar hit new lows against the euro and a basket six of major currencies. Oil hit a new high of nearly $112 a barrel on the weaker dollar.

Investors dived into safe haven assets, lifting gold to more than $1,030 an ounce at one point and sending yields on short-dated euro zone debt below 3 percent for the first time in more than two years.

"The markets are in a complete state of panic and in such situations there is no such thing as valuation or value in any asset," said Michael Klawitter, FX strategist at Dresdner Kleinwort in Frankfurt.

In a shock move late on Sunday, the Fed lowered the discount rate it charges on direct loans to banks to 3.25 percent from 3.50 and implemented steps to provide cash to a wider range of financial firms, using tools last used in the Great Depression.

Minutes earlier, JPMorgan Chase & Co had said it would buy Bear Stearns for a rock-bottom price of $2 a share, valuing the U.S. investment bank at the centre of a widening global credit crisis at about $236 million.

JPMorgan and the Federal Reserve Bank of New York temporarily bailed out Bear Stearns on Friday after a deterioration in its liquidity, one the worst cases yet in a broad-based drying up that has been going on since mid-2007.

LIQUIDITY SQUEEZE

Investors are now nearly fully pricing in a 1 percentage point cut in the main federal funds rate at or before the Fed's policy meeting on Tuesday.

That would take U.S. rates down to just 2.0 percent.

"Desperate times need desperate measures. The Federal Reserve is doing what it takes to restore stability," said Craig James, chief equities economist at Commsec in Sydney.

There were also signs of continuing liquidity worries -- three-month interbank lending rates for euro and sterling leapt.

The Bank of England said it would offer 5 billion pounds ($9.85 billion) of three-day funds in an exceptional fine-tuning operation designed to bring overnight interest rates down.