U.K. Economy Shrinks, World Markets Tank

Britain's economy shrank in the third quarter as the global credit squeeze took its toll, according to figures out Friday, confirming that the country is on the brink of its first recession since 1991. The pound plunged.

Also, world stock markets tumbled Friday on growing alarm that a global recession will ravage corporate profits.

Britain's economic output declined by 0.5 percent last quarter, according to the Office for National Statistics. Analysts expect the economy to further shrink, reports CBS News correspondent Richard Roth.

The contraction in growth in the July to September quarter had been widely expected but the 0.5 percent dip was greater than anticipated, sending share prices and the British pound spiraling downward.

"Every business, every individual - we have to live within our means," warned British Treasury chief Alistair Darling as the statistics showed that businesses from financial services to hotels and catering are in decline.

The growth figures for the third quarter mark the first half of the definition of a technical recession used by government: two or more consecutive quarters of negative economic growth. Economists say that the current quarter, October to December, is certain to continue the trend.

"The economy is already in recession," said Hetal Metha, a senior economist at the Ernst & Young Item Club. "We'll get confirmation in January when the Q4 numbers are out, but today's figures highlight how serious the situation is."

Prime Minister Gordon Brown and his central bank chief, Mervyn King, tried to ease the blow earlier this week by breaking ranks with many other world leaders to use the dreaded "r-word," declaring that a recession was almost certain.

However, the London Stock Exchange and the British pound, which had already fallen after those comments, extended losses as the fall in economic output was larger than the anticipated 0.2 percent.

The pound dropped to a five-year low against the U.S. dollar as investors bracing for interest rate cuts in the wake of the economic data took their money elsewhere in search of higher yields. The currency plunged to $1.5264 before recovering slightly to change hands at $1.5590 at midday, down some 3.6 percent on the day.

The FTSE 100 index of leading British stocks plunged nearly 8 percent to 3,766 as traders bet that the country's economic contraction will make it more difficult for companies to pocket profits.

The contraction in economic output - the first since the second quarter of 1992 - is a blow for Brown's previously unbroken record of growth since the Labour Party came to power in 1997. Brown, first as Treasury chief then as prime minister, has prided himself on providing "stability" to ordinary Britons who have until recently benefited from rising house prices and low unemployment.

Meanwhile, Wall Street's recovery after an initial plunge helped drag European indexes out of the depths Friday. Germany's benchmark DAX index closed 4.96 percent lower, or 224 points, at 4296, after being down more than 10 percent at one point. The French CAC40 closed 3.54 percent at 3194. It also traded over 10 percent lower during the trading day. Britain's FTSE 100 closed down 5.0 percent at 3,883.

Russia's two exchanges were shut down early because of excessive losses and officials said they wouldn't resume trading until Tuesday — the MICEX was 14.2 percent lower and the RTS down 13.7 percent. Japan's Nikkei 225 stock average closed down 9.6 percent to 7,649.

The pressure on stocks was a combination of poor earnings reports as well as fear among investors that the financial crisis will turn into a global recession that will endanger small economies previously uninvolved in the credit crunch.

Profit warnings have come thick and fast across all industries. Shares in Europe's automotive companies fell hard on worrying third quarter figures, with truck-maker Volvo AB down 17 percent and PSA Peugeot-Citroen falling 5.9 percent. Daimler AG and Fiat Spa also warned about profits.

But heavy industry was not the only sector to feel the pain, with the likes of Sony also warning of tough times ahead. Its shares slid 14 percent in Asia.

The sudden gloom over growth expectations is having the added impact of putting small economies and currencies under extreme pressure. Investors are pulling money out of countries in Eastern Europe, Latin America and Asia on fears vulnerable countries will not only be hit hard by the financial crisis but may also default on debt.

"Volatility and uncertainty seem to be the watch words at the moment," said Matt Buckland at CMC Markets in London.

He suggested the market sell-off may now be overdone, but urged caution.

"There's perhaps a question to be asked as to whether more value can still be taken out of the market, but we had the same debate when the FTSE 100 was around the 5,000 level and history shows us that indeed it could," he said.

As investors flee economies they view as less stable, this rush for the exit to repatriate money has boosted the dollar to the detriment of smaller currencies.

"For now this means much of the focus is on the International Monetary Fund and what it might have in mind to insulate emerging markets, given that they are now the clearest pressure point," said Maher.

Markets are afraid that the world may see more countries go the way of Iceland, whose financial sector collapsed earlier this month.

In Europe, Hungary, Ukraine and Belarus are all, like Iceland, in talks with the IMF to discuss possible loans. Iceland received a $2 billion loan Friday.

Currencies saw massive swings as markets sought to identify which countries are most at risk, while some investors took bets on cheap bargains. The euro, which analysts consider exposed to the vulnerable Eastern European markets, fell to a two-year low against the dollar, dipping below the $1.25 level before recovering somewhat to trade at $1.2680. The British pound dropped as low as $1.5264 against the dollar, the weakest since August 2002, before rallying back to $1.5830.

Ashraf Laidi at CMC Markets noted that the pound's early fall was the biggest intraday move since exchange rates became freely floated in 1971.

Although the dollar has enjoyed huge gains against most other currencies throughout the past month of financial crisis, it has tumbled against the yen. It fell Friday as low as 90.89 yen, the weakest since August 1995. The dollar likewise recovered some of those losses, rebounding to 93.00 yen.

The dollar's drops in against the yen are due to the fact that traders borrow in yen to fund riskier investments, so when investors are scared of losing money in emerging markets they buy the yen back, boosting its value.

"We are getting used to wild swings in the markets, but today's moves verge on the bizarre," said Julian Jessop, chief international economist at Capital Economics.

Hong Kong's Hang Seng index fell 8.3 percent to 12,618. Markets in India, Thailand, Indonesia and the Philippines were also down sharply as investors bailed out of emerging markets to cut their exposure to risky assets and meet needs for cash at home.

"Funds are pouring out of emerging markets," said Linus Yip, a strategist at First Shanghai Securities in Hong Kong. "A lot of money that flowed into the region during the last five years from the U.S. and Europe is being cashed out.

On top of all this, the Organization of the Petroleum Exporting Countries Friday cut its output by 1.5 million barrels a day in an effort to keep oil prices higher.

This had little effect on markets, with the price of light, sweet crude for December delivery slumping $4.69 to $63.15 a barrel, over 50 percent less than this year's historic heights.