Market rally halted by eurozone fears

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Fears of political upheaval in Spain and Italy dramatically doused confidence in stock and bondmarkets bringing 2013’s record breaking rally to a sudden halt.

The borrowing costs of Spain and Italy - the eurozone's third and fourth biggest economies - jumped and equities plunged as the spectre of the return of the debt crisis gripped traders.

In London, the FTSE100, which was heading for a four year high, suffered its biggest fall for three months which wiped £25bn off the value of Britain’s biggest companies. London’s leading index closed down 1.6pc.

Spain’s borrowing costs jumped to their highest level this year as corruption allegations threatened to engulf Mariano Rajoy’s government. Traders ignored Mr Rajoy’s strong denials that he and senior members of his party were beneficiaries of a secret slush fund and pushed the yield on benchmark 10-year bonds to 5.4pc.

Italy’s bond yields rose to 4.5pc amid the resurgent popularity of Silvio Berlusconi who is campaigning to be returned as prime minister on an anti-austerity vote.

Milan’s MIB index plunged 4.5pc while Madrid’s Ibex fell 3.75pc. Europe’s leading indicies followed - Germany’s Dax (Xetra: ^GDAXI - news) dropped 2.41pc and in France the CAC was down 2.87pc.

Europe’s banking sector - the most exposed to sovereign debt - was the worst hit. In the UK, the Chancellor’s pledge to toughen-up banking regulation spooked traders who decided to cash-in on the sector’s 10pc rally so far this year; the sector fell 2.2pc.

Angus Campbell from Capital Spread said it was as though a “large bucket of cold water was poured onto the equity market rally.” He said the “significant spike in the government bond yields for the worrisome eurozone countries such as Spain and Italy, which in turn triggered an aggressive decline in bank shares causing some European indices to almost completely wipe out the gains they’ve built so far in 2013.”

Analysts said some parts of the sell-off were overdone. Phil Roberts, an analyst at Barclays (LSE: BARC.L - news) , told reporters: “I would be more inclined to think that it’s a correction rather than a trend-ending scenario.”

However Mr Campbell added: “The other slightly worrisome signal about today’s move lower is that volumes were higher than average, indicating that this is a concerted move to the downside with investors running for cover and could possibly be followed by further weakness in the days ahead.”