The paralysis in money markets is feeding through into the wider economy, with blue-chip nonfinancial companies suddenly finding it impossible to borrow short-term, or only at penal rates.

Industrial and commercial companies outside the financial sector have been caught out by the sudden drying-up of investor appetite for commercial paper (CP), the standard way for large companies to borrow for a few days to a few months. Martin O’Donovan, assistant director at the Association of Corporate Treasurers, said that the change in sentiment over the past few days was extraordinary. “Corporate treasurers are surprised by what has been going on since the Lehman collapse. The nervousness about financials has to some extent spilled over into ordinary corporates,” he said.

Demand from investors for blue-chip CP maturing in one to three months had in most cases dried up, Mr O’Donovan said. Corporates were suddenly unable to borrow in the CP market for more than a few days at most. Instead, they were having to call on much more expensive bank borrowing facilities. Given the blowout in Libor, the benchmark for pricing all kinds of loans, blue-chip companies were typically paying a full percentage point more on short-term debt than they were a month ago, Mr O’Donovan said.

Companies borrow to meet day-by-day needs by issuing billions of dollars, euros and pounds in CP, which till recently has been a highly liquid and cheap way of raising short-term finance. The warning that the financing squeeze was spilling farther into the real economy came as markets remained transfixed by the fate of Washington’s $700 billion (£380 billion) bailout plan for the US banking system. As the plan hung in the balance, British banks were working on alternative rescue proposals, arguing that the Government might have to come up with its own plan for taking over toxic assets if conditions continued to worsen. It was not clear last night the extent to which UK banks would be able to use the US plan, even if it goes ahead.

The protracted political wrangling in the US sent shares down again and sparked a renewed dash by alarmed investors for the safe-haven holdings of gold and government bonds.

The FTSE 100 index of blue chips finished 109 points lower at 5,088, down 4.2 per cent on the week. In New York the Dow Jones industrial average was down 71.80 points at lunchtime, and the broader-based S&P 500 index endured a sharper sell-off, falling by as much as 1.5 per cent.

The collapse of Washington Mutual, the largest US thrift group, inflamed anxieties over the fallout from the credit crisis. Shares in US banking groups were hit again, with Wachovia, one of America’s leading banks, down by more than 28 per cent.

In the eurozone, Fortis, the Belgian-Dutch bank, denied that it faced a liquidity crisis but its shares slumped by 15 per cent to a 20-year low.

A downgrade to the performance of the US economy in the second quarter added to the nervousness. GDP growth in the quarter was scaled back to an annualised 2.8 per cent, from the previously reported 3.3 per cent, mainly because of weaker estimates of consumer spending in the period.

Central banks in Europe battled to stem stresses in money markets with further huge injections of short-term funding. The Bank of England, the European Central Bank and the Swiss National Bank injected one-week dollar funds in the interbank lending market for the first time, auctioning $74 billion of loans to their banking groups.

The Bank of England auctioned $30 billion of dollars to British banks and said that it would also make £40 billion in three-month sterling funds available in an auction next week. Market hopes that the crisis would lead both the ECB and the Bank of England to bow to pressure to cut interest rates before the end of the year also continued to rise.

Despite the interventions, strains in money markets remained severe. Although the cost of overnight and three-month lending between banks in dollars and sterling fell back from recent highs, stress was apparent in interbank lending in euros. Shares in Bradford & Bingley were under selling pressure again, falling by 6 per cent to close at a record low of 20p amid continuing doubts that it can survive as an independent bank. Banking crisis, pages 63-65

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts