By Jeremy Gaunt
LONDON (Reuters) - Fears of global recession and a flight from emerging markets overshadowed signs on Wednesday that government attempts to end the gravest financial crisis in 80 years may be bearing fruit.
Stocks from London to Tokyo fell sharply on worries about the wider impact of the crisis which pushed the global financial system to the brink of collapse, forcing governments to prop up banks and central banks to sustain money markets.
Emerging market debt and currencies came under severe stress, prompting Hungary to ratchet up interest rates by three full points to defend its ailing forint currency.
But there were optimistic noises from various officials.
Treasury Undersecretary David McCormick, speaking in Hong Kong, said the U.S. economy was in for a challenging few quarters but could start to recover late next year.
"The name of the game is to bring back confidence to the financial market," he said.
Mervyn King, Governor of the Bank of England and a major player in Group of Seven nations' discussions on the crisis, said that for the financial system the worst may have passed.
"We are far from the end of the road back to stability," he said late on Tuesday. "But the plan to recapitalize our banking system, both here and abroad, will I believe come to be seen as the moment in the banking crisis of the past year when we turned the corner."
His comments were underlined by U.S. dollar short-term funding costs falling further in London and Asia, a sign banks are beginning to regain trust in each other.
Emerging powerhouse Russia, whose markets have been battered during the crisis, also signaled improvements in bank lending.
"The interbank has started working normally. The rates are high but coming down. Banks have started crediting sectors again. But we still need two or three weeks for the situation to start improving," the Financial Times quoted First Deputy Prime Minister Igor Shuvalov as saying.
Official help was still at hand, however, with the Federal Reserve on Tuesday saying it could lend up to $540 billion to buy certificates of deposit and commercial paper from money market funds, which have struggled to cope with a wave of withdrawals by investors.
Australia and New Zealand were forced to tweak their plans to guarantee bank deposits after media warned the moves had caused financial dislocation by prompting a rush of money from uncovered schemes into the back-stopped deposits.
Argentina on Tuesday took over the $30 billion private pension system to guarantee pensions.
RECESSION LOOMS
Emerging markets became the latest hotspot in the cycle of global turmoil.
MSCI's emerging market stock index was at its lowest since June 2005 and emerging market sovereign debt spreads widened beyond 700 basis points over Treasury yields for the first time since early 2003.
Currencies were also battered, with the Turkish lira falling to the lowest in more than two years and South Africa's rand at its lowest in more than 6 years against the dollar.
Ukrainian Prime Minister Yulia Tymoshenko said she expected the International Monetary Fund to decide on a loan for her country later in the day.
The IMF is also ready to help Pakistan, which needs funds to avoid a balance of payments crisis, and Iceland, driven close to bankruptcy as frozen credit markets caused its banks to fail.
The overarching fear, overshadowing the progress made in fighting financial collapse, is worry about the deteriorating global economic climate. Minutes from the Bank of England's last meeting, at which it joined a coordinated round of rate cuts, said the UK economy had deteriorated substantially and King, in his Tuesday comments, said it was probably entering its first recession in 16 years.
Such worries swept financial markets outside of emerging economies as well. European shares were down more than 2.7 percent on Wednesday and Japan's Nikkei average ended down 6.8 percent.
"Now we are going to have to deal with the problems of a business cycle downturn, which in all likelihood will be a fairly intense one," said Sanjay Mathur, economist at the Royal Bank of Scotland in Singapore.
A slew of U.S. company results later on Wednesday will give a snapshot of conditions across an array of industries and sectors in the world's largest economy.
Struggling bank Wachovia Corp, set to be taken over by Wells Fargo & Co, will report third quarter figures as will Boeing, tobacco giant Philip Morris, oil major ConocoPhillips and McDonald's among others.
(Editing by Mike Peacock)
