The battered stock market was on the brink of sliding into a new bear market last night as mounting fears of stagflation, sparked by another spate of bleak economic news, sent blue- chip shares plunging once more.

In a grim start to the second half of the trading year, the FTSE 100 index tumbled 146 points, or 2.6 per cent, to close at 5,479.9, at one point sinking to a three-month low.

The blue-chip benchmark’s latest steep losses came after the FTSE index lost nearly 13 per cent in the first half, marking a stark contrast with its 6.2 per cent rise in the same period last year and ending a long bull run of five consecutive years of gains.

Yesterday’s latest plunge left the 100-share index down 18.5 per cent, nearing the 20 per cent drop from last year’s peak that officially marks the threshold of a bear market.

Keith Bowman, of Hargreaves Lansdown, the broker, said: “It is a pretty nervous start to the second half. Worries over bank writedowns just won’t go away.”

The London market’s gloom was compounded as the Dow Jones industrial average also succumbed to further sharp losses that left it, too, entering bear-market territory. By early afternoon on Wall Street the Dow Jones industrial average was down more than 1 per cent, before closing up 32.30 points at 11,382.30.

Earlier the steep sell-off in the FTSE was fuelled when investors took flight from equities as fear of an outbreak of Seventies-style “stagflation” was stoked by key manufacturing figures showing a toxic combination of stalling growth and rising inflation that some economists fear will effect the economy as a whole.

The fragile revival in Britain’s manufacturing appeared to have run out of steam as the sector shrank for a second month in a row in June, and at the fastest pace since the end of 2001, according to the latest CIPS purchasing managers’ survey.

Overall manufacturing activity succumbed to its worst slump for eight and a half years, according to the CIPS headline index, which tumbled 3.7 points to 45.8 for last month, on a scale where any reading under 50 indicates contraction. Industrial output and orders in June suffered the sharpest falls for almost a decade, while the pace of job layoffs in the sector accelerated to its worst for almost three years.

Yet the figures also showed that inflationary pressures in manufacturing are mounting. Both the survey’s index of industry’s costs for raw materials, components and fuel, and its measure of prices charged for goods leaving factories set records.

Costs rose at their fastest pace since 1992, fuelled by soaring oil prices, while output prices charged by manufacturers climbed at their fastest since 1999, in data that will ring alarm bells at the Bank of England amid growing speculation that it could soon raise interest rates. Oil prices leapt back towards record highs yesterday, with benchmark US light crude up by $2.60 at $142.60 a barrel by late afternoon.

The threat that the Bank will move to quell mounting price pressures with a rate rise was heightened by a separate YouGov poll for Citigroup showing that the public’s expectations of future inflation set a new high last month. The average expected level of inflation over the 12 months jumped to 4.6 per cent — more than twice the Bank’s 2 per cent target.

The Bank fears that expectations of faster price increases will stoke pay demands, making higher inflation a self-fulfilling prophecy. Its dilemma over its next move was sharpened, however, as other figures emphasised the threat of a severe economic downturn, with 11 years of uninterrupted growth in the construction sector ending in the second quarter, according to the Royal Institution of Chartered Surveyors.

A similar quandary for the European Central Bank, which is widely tipped to raise interest rates tomorrow, was underlined as eurozone manufacturing activity also fell last month for the first time in three years, according to a purchasing managers’ survey.

The ECB came under more intense pressure to rethink the expected rate rise after a broadside from President Sarkozy of France. “Today’s inflation is caused by exploding commodity prices, so don’t try to tell me rates must rise to fight inflation,” he said.

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