The US Federal Reserve dashed hopes for a cut in American interest rates to help to quell the financial convulsions racking global markets in the wake of the collapse of Lehman Brothers.

The US central bank’s hardline decision to keep its official rates pegged at 2 per cent came despite another tempestuous day for markets as financial upheavals escalated following the failure of Lehman and amid fears over the fate of AIG, the embattled insurer.

The Fed’s tough verdict came even after it united earlier with other leading central banks to wage an increasingly fraught battle to limit the fallout from the crisis now shaking the foundations of Wall Street.

The world’s key money markets were in a state of near-seizure for much of today as the shockwaves from Lehman’s closure sparked a panicky scramble by investors to dump shares and risky assets and secure short-term cash to see them through the worsening financial storm.

US stock markets reacted edgily to the Fed’s decision to spurn pressure for an immediate rate cut to ease the threat of a financial meltdown.

The Dow Jones industrial average see-sawed in and out of negative territory after the Fed announcement, having earlier clawed back ground after Monday’s brutal sell-off of US bluechip shares inflicted their sharpest losses in seven years. By late afternoon in New York, the Dow stood about 100 points higher.

Equity markets in Europe and Asia succumbed to another severe battering that drove world share prices to their lowest for three years.

In London, the FTSE 100 index plunged by another 178.6 points, or 3.4 per cent, to end a bloody trading day at a three-year low of 5,025.6.

Another £43 billion was wiped off the value of Britain’s leading shares adding to losses of £50 billion on Monday as anxieties over the toll on the UK financial sector from Lehman’s collapse persisted. In Europe, shares also finished at their lowest since 2005.

Central banks had earlier sought to stem financial turbulence by pumping in a massive $160 billion (£89.6 billion) in short-term funds into money markets. The Bank of England injected another £20 billion into London markets on top of £5 billion provided yesterday, while the European Central Bank injected €70 billion, more than double the €30 billion supplied to eurozone markets on Monday.

Despite these efforts, there were intense stresses in markets for lending between banks sparked by a ferocious appetite for short-term cash.

At one stage, the interest rate for overnight dollar funds leapt to 11.6 per cent — more than four times the Fed’s official rate. In London, the overnight “Libor” rate for dollar funds more than doubled to 6.4375 per cent, its highest since January 2001, exceeding the highest rates reached when the credit crisis first erupted last August.

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