Share prices were on a knife-edge yesterday as hopes that central banks had engineered a return to normality battled with fears that the credit crisis is far from over.

A €40 billion (£27 billion) infusion of funds by the European Central Bank (ECB) to assist banks hit by US sub-prime woes, and the Bank of Japan’s decision to keep interest rates on hold, brought an early boost to Britain’s stock market.

However, the FTSE 100 index saw its early gains wiped away after shares tumbled on Wall Street as Countrywide, the biggest US mortgage lender, gave warning of a housing-led recession in America. The index closed up just 0.02 per cent, at 6,196.90, its weakest performance in a week.

Some 146 banks bid for the ECB’s €40 billion injection of three-month funds to the interbank money market, its first such move outside the normal monthly schedule. The liquidity transfusion helped the pan-European FTSEurofirst 300 index to rise 0.5 per cent, its fifth consecutive day of gains.

The US Federal Reserve followed suit, adding $17.25 billion (£8.6 billion) into the financial system. A poll suggested that Wall Street analysts expect the Fed to cut its main interest rate twice by the end of the year, taking US rates down to 4.75 per cent.

Hopes that US rate cuts could stabilise the markets helped sterling to rise above $2. The pound strengthened against the Japanese yen as traders said that increased appetite for risk was generating fresh interest in the carry trade between the two currencies.

Investors are unlikely to see the full damage that turmoil in credit markets has wrought on the banks until their third-quarter results are released. The market is watching for signs of discomfort.

In the US, hopes that Countrywide was on a firmer footing after a $2 billion capital infusion by Bank of America were set back after the chief executive of the home-loan provider struck a negative tone on the housing market. Angelo Mozilo, Countrywide’s founder, said: “If this trend continues, it’s going to have an impact on the overall economy. I’ve seen this movie before, and the ending of the movie always ends up in some form of recession.”

In a note to clients, Bill Gross, managing director of Pimco, the world’s largest bond fund, urged President Bush to step into the housing mêlée. He said the President should use federal funds to support struggling mortgage owners and stabilise markets.

US government bond prices dipped slightly as the lack of further negative surprises fanned speculation that the Fed would wait until its scheduled meeting on September 18 before cutting rates.

David Coard, head of fixed-income sales in the Williams Capital Group, said: “There does seem to be a sense of stability in the money markets, but it doesn’t look like we’re going to go back to the way things were.”

In another encouraging sign, BNP Paribas, the French bank, announced that it would reopen its three frozen funds next week, saying that liquidity conditions had improved enough to allow their value to be calculated again.

Explore Economics

• Autumn Budget 2007

• Budget 2008

• World Economic Forum

• The Times MPC

Times Recommends

• Darling under pressure on record public debt
• Mortgage lending falls 32% as drought deepens
• Oil prices firm after 10% drop to below $130