World stocks hit 2-week low as pound skids

By Natsuko Waki

LONDON (Reuters) - World stocks fell to a two-week low on Thursday after Washington backed away from its plan to buy toxic assets, while sterling hit fresh 12-year lows a day after the Bank of England warned of a sharp economic slowdown.

Oil hit a 22-month low below $55 a barrel before it regained poise. Short-term European government bond yields fell to a three-year low as data showing Germany had slipped into recession spurred appetite for safer government bonds.

The Bush administration largely abandoned its plan to buy up toxic mortgage assets and it will focus its $700 billion (470 billion pound) financial bailout fund on making direct investments in financial institutions and shoring up consumer credit markets.

This, combined with a dismal forecast from Best Buy and a revenue warning from Intel, weighed on Asian and European shares.

"This is a case study of a massive deflationary economic situation that is building up. There is no doubt we are entering into a recession and it could be pretty nasty and deep," said Valerie Plagnol, chief strategist at CM-CIC Securities in Paris. The MSCI world equity index fell 1.2 percent, approaching October's five-year lows, while the FTSEurofirst 300 index fell 0.7 percent. U.S. stock futures pointed to a firmer open on Wall Street later.

Sterling fell as low as $1.4807, its lowest in 6-1/2 years and 82.0 on a trade-weighted basis. It also hit a record low of 84.56 pence per euro. The dollar fell 0.6 percent against a basket of major currencies.

The Bank of England said in a quarterly inflation report on Wednesday that the economy was likely to contract further next year and inflation could fall below 1 percent in two years.

Investors expect the Bank to follow up November's shock 1.5 point interest rate cut next month with another half a point reduction as it tries to drag Britain out of recession. The cost of borrowing now stands at 3 percent.