Shares fell sharply on both sides of the Atlantic and the dollar tumbled to a 15-year low against leading currencies yesterday, as world markets continued to be shaken by fears over US sub-prime mortgages.

The Dow Jones industrial average sank about 100 points as concerns grew that weakness in risky mortgages was spreading to supposedly safer prime loans, potentially sparking a credit crunch in the US economy.

Bill Gross, the influential manager of Pimco, the world’s largest bond fund, gave warning of a “sudden liquidity crisis” in junk bonds as lenders took fright at soaring defaults.

Traders sold off dollars, pushing sterling to a 26-year high of $2.0655 and the euro to a record $1.3853. The FTSE 100 fell by 125.7 points, losing more than £35 billion of value, to close at 6,498.7, as markets tracked changes in New York amid confusion over the near-term path of interest rates.

A CBI survey showed that industrial output was starting to wane, in the first sign that manufacturing’s recovery may be feeling the heat from sterling’s strength. New orders rose at their weakest pace since October and export order volumes fell noticeably for the first time in 18 months.

Sir John Gieve, the Bank of England’s deputy governor for financial stability, added to stock market jitters when he said that key parts of Britain’s lending markets faced risks similar to those of the US sub-prime sector. In a speech in the City, he argued that some institutions might have had too lax a policy for issuing credit card and personal loans.

Commercial property loans and some leveraged corporate loans were also affected by a failure of lenders to account for cyclical factors, he said. “In traditional banking markets in the past, there has been an observable tendency for banks to overshoot both in offering credit at the top of the cycle and retrenching afterwards. That feeds through into asset prices and can have an impact on the wider economy. Despite the sophistication of the new capital markets, a very traditional cycle seems to have been alive and kicking in sub-prime.

“A similar story could be told about the credit card and other unsecured lending over the last few years . . . there are clear signs, at least in unsecured credit for households, that the lenders overshot.” He said that the position in the mortgage market and mainstream corporate lending was less clear. That lack of clarity made the job of the Bank of England’s rate-setting Monetary Policy Committee more complicated.

However, Sir John also cautioned against the danger of becoming “alarmed by good news”. He said that there had been a healthy correction to the low pricing of risk in credit markets in recent months. He also argued that the slide in the dollar would help to secure an orderly unwinding of the huge imbalances between the world’s key economic blocs, symptomised by the huge US current account deficit.

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