UK bank funding talk hits stocks, sterling

By Natsuko Waki

LONDON (Reuters) - World stocks fell again on Tuesday and sterling hit a 2-1/2 year low after talk of government funding hit UK banks, erasing gains in the benchmark index made after Australia's surprisingly large interest rate cut.

Royal Bank of Scotland fell more than 30 percent while Lloyds also lost 18 percent after traders cited speculation of funding talks with the government.

In Iceland, the government has dismissed the board of directors of Landsbanki and has put the Icelandic bank in receivership. The crown currency lost 35 percent to record lows of 350 per euro, on top of a 30 percent fall on Tuesday.

Earlier, Australia cut interest rates by a full percentage point to 6 percent, its biggest move in 16 years. This has boosted speculation other major countries might follow suit, especially as finance chiefs from Group of Seven rich countries meet in Washington this weekend.

Interbank money markets -- blocked for months by banks' refusal to lend to each other -- remained log jammed, with the cost of borrowing euros for three-month staying as high as 5.38 percent on Reuters system.

"A concerted move by central banks to cut global rates would be seen as an unmitigated positive ... the market's suspecting that's the case," said Jeremy Batstone-Carr, head of private client research at Charles Stanley.

"The macro backdrop is deteriorating and while the pace of the deleveraging process has taken everyone by surprise by its intensity the inevitable consequence is going to a longer and deeper economic downturn."

The FTSEurofirst 300 index fell 1.15 percent after falling 7.8 percent to four-year lows on Tuesday. MSCI main world equity index fell 0.5 percent, having lost more than 9 percent this month alone.

The low-yielding yen fell half a percent to 101.89 per dollar and fell from a five-year peak against the Australian dollar after Australia's interest rate cut. The dollar fell a quarter percent against a basket of major currencies.

Sterling fell as low as $1.7322 with interest rate futures pricing in the chance that the Bank of England would cut interest rates by at least 50 basis points.

"The focus is on the RBA and what it has done for rate expectations elsewhere," said Adam Cole, global head of currency strategy at RBC. "The risk of larger moves by central banks has risen significantly."

The December Bund future gained 9 ticks, underpinned by capital seeking safer government bonds.

Emerging sovereign spreads tightened 7 basis points while emerging stocks fell 0.5 percent, after falling more than 10 percent on Tuesday.

U.S. light crude rose 2 percent to $89.58 a barrel, while gold also gained to $872.10 an ounce.