By Keith Weir and Simon Rabinovitch
LONDON/BEIJING (Reuters) - Investors looked to central banks and politicians on Tuesday to show they could contain an escalating financial crisis after Australia responded by cutting interest rates sharply.
Equities across much of Asia and commodity prices rallied after the Australian central bank slashed its benchmark cash rate by 100 basis points, the biggest single cut since 1992.
European stock markets, which suffered record losses on Monday, were expected to make up some lost ground. However, Japan's Nikkei share average finished at a five-year low as the panic that swept through Europe and the United States reached Tokyo.
U.S. officials have called for a "forceful and coordinated" global reaction to kickstart anaemic bank lending but such a unified approach remains elusive.
European Union finance ministers meet in Luxembourg on Tuesday to try to flesh out promises to counter market mayhem and ensure no savers lose any money. The EU has been criticized for its fragmented response to the crisis and the way individual countries have broken ranks with deposit guarantees.
The banking upheaval that began on Wall Street has effectively shut down interbank and other loan markets, pushing industrialized countries closer to recession. Conditions remained poor for interbank lending.
Economists said the Australian rate cut might be followed in Europe and the United States.
"If the need is there to get rates down toward something that's more neutral, then why dilly dally? Get it done in one go," said Brian Redican, an economist at Macquarie. "It's a flexibility other central banks should take careful note of."
Japan's central bank, with far less room to maneuver, voted to keep rates unchanged, but gave a grim prognosis for the economy that hinted at more actions to boost liquidity.
Fed fund futures have priced in a probability of a 75 basis-point cut by the U.S. central bank this month.
However, there were already doubts about whether the aggressive rate cut in Australia could shock the country's banks back into lending, with the National Australia Bank holding off on lowering its standard variable rate until markets calmed.
ICELAND BANKRUPTCY FEAR
The furious sell-off in global equities in recent weeks and the deepening freeze in credit markets has made this week's Group of Seven rich nations' meeting in Washington even more important.
"The key issue is coordination of policies, since individual country policies aimed at shoring up confidence of domestic institutions can actually exacerbate systemic risk," said Ashley Davies, a currency strategist with UBS in Singapore.
Speculation is swirling that China, with U.S. bonds making up the lion's share of its $1.81 trillion in foreign exchange reserves, the world's biggest stockpile, could have a key role to play in any global response.
But Liu Mingkang, the country's banking regulator, denied that Beijing might ride to America's rescue by pumping cash into the United States.
The extent of the crisis was illustrated when Iceland's prime minister warned his country was threatened with "national bankruptcy."
Iceland agreed to adopt sweeping powers over banks on Monday as its financial system tottered, its currency plunged 30 percent and a leading agency cut its credit ratings.
The small country's financial stature had swelled in recent years as its banks expanded overseas, investors took large positions in its high-yielding currency and foreign firms poured money into local projects.
SELL-OFF
In the second full day of global trading after the U.S. Congress approved a $700 billion bailout intended to reassure markets, it was clear that whatever reassurance had been delivered was insufficient.
Instead, a crisis that began with the overheated U.S. property market was still shaking confidence worldwide.
Looking to avoid potential trouble spots in the global storm, investors turned against South Korea, worried about the country's relatively high level of household and small-company debt.
The South Korean won dropped nearly 6 percent to the lowest in more than seven years against the dollar, despite assurances from the government that Asia's fourth-largest economy was not facing a currency crisis.
Emerging markets, which had gained mightily from the surging global expansion in the last three years, were sucked into the vortex. Trading was halted in markets as far afield as Brazil and Russia when stocks plunged.
Mexico's peso sank to its weakest level since the currency was allowed to float in the mid-1990s, and stocks plunged.
(Reporting by Reuters bureaus worldwide; Editing by Jean Yoon and Ralph Boulton)
