What could be worse than the credit crunch? We’re about to find out

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The markets have finally woken up to the fact that there are worse things out there than the credit crunch.

The vague hope that the financial fall-out was over has seen stock markets around the world rally somewhat since their low points earlier this year. But news at the end of last week knocked them for six.

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The Dow Jones dived nearly 400 points on Friday, and the turbulence has continued this morning.

So what's shaken them up?

Why Dow Jones plunged nearly 400 points on Friday

The end of last week brought the market face to face with a grim reality that it didn't really want to hear: that inflation is loose in the system, and it's not going to vanish any time soon, credit crunch or not.

Earlier in the week, Ben Bernanke had reassured the markets, by indicating that he was aware of the weak dollar and high inflation. Normally, the markets wouldn't like anything that smacked of higher interest rates, but they know Bernanke too well for that. The Federal Reserve chief has always said that saving the economy from a depression was his top priority. The idea that he might actually raise interest rates to protect the dollar was out of the question.

So while the dollar staged a rebound, the boys on Wall Street knew that their man in the Fed was still on their side. Maybe if he could just talk the dollar back up, while keeping rates low, the US could have its cake and eat it.

Sadly for Bernanke, the markets got to hear a real inflation fighter talking just a few days later. Jean-Claude Trichet, head of the European Central Bank, basically came out and said that interest rates in the eurozone would probably go up next month because inflation is too high.

That smacked the dollar right back down. And as the dollar slumped, the price of oil rocketed not helped by some outright talk of attacks on Iran by Israel. Worse still, US unemployment data on Friday was dreadful. The unemployment rate jumped from 5% to 5.5%.

With oil having hit near $140 a barrel, and with analysts lining up to see who can give the largest target for its next stop (top bid so far is $200 a barrel from Goldman Sachs), it's no surprise that we're seeing stagflation' headlines everywhere. This morning, The Telegraph quotes former Monetary Policy Committee member Willem Buiteras warning that British people face a falling standard of living, and rising unemployment. He believes the MPC should raise rates by another half point.

Of course, not everyone believes that inflation will be the problem in the end. As Ambrose Evans-Pritchard points out in the same paper,while emerging markets are certainly facing inflation, here in the West, the credit crunch and falling house prices are deflationary. James Fergusonand Merryn Somerset-Webbdebate both sides of the story in this week's cover story (if you're not a subscriber, sign up here to get your first three issues FREE).

The outlook for landlords just keeps getting worse

One thing's for sure. Inflation or deflation, nothing the MPC does now can save the British property market. There was more bad news for landlords this morning. One of the more persistent claims about buy-to-let is that rents will keep rising as first-time buyers fail to get on the property ladder. Therefore, landlords will be able to cling onto their portfolios, and may even profit from the credit crunch.

This has always been nonsense rents might rise, but so will mortgage costs, and while one's negotiable, the other isn't. A new survey also shows that it's not just landlords who are having trouble. The credit crunch might be hurting mortgagees, but it's also pretty tough to pay your rent if you've lost your job. A survey by market researcher BDRC found that profitability among landlords is at its lowest and levels of missed rent at their highest since the survey began (admittedly only in October 2006). Nearly one in five landlords had missed a mortgage payment in the past quarter because of non-payment of rent.

Whatever the optimists say, buy-to-let is very much the weak spot of the market. As times get harder, expect more and more former rental flats to end up on the auction block. Everything else might be getting more expensive, but there's only one way for property prices to go now down.

Turning to the wider markets

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On Friday, the high oil price and bad news on US jobs saw the FTSE 100 index lose 88 points to close at 5,906. British Airways was the biggest faller.

European markets were also lower, with the German Xetra Dax sliding 138 points to 6,803 and the French CAC 40 falling 111 points to 4,795.

US stocks were hammered as oil prices and unemployment rose sharply. The Dow Jones Industrial Average dived 394 points to close at 12,209, the eighth-largest points drop in its history, according to Marketwatch. The wider S&P 500 fell 43 points to 1,360 and the tech-heavy Nasdaq Composite dropped 75 to 2,474.

Overnight the Japanese market followed the US lower. The Nikkei 225 fell 308 points to end at 14,181.

Brent spot was trading this morning at $137.30, while crude traded at $137.81 in New York. Spot gold was at $907. Silver was trading at $17.60 and Platinum was at $2,081.

In the forex markets, sterling was weaker against both the US dollar at 1.9715 and the euro at 1.2455. The dollar was trading at 0.6319 against the euro and 105.23 against the Japanese yen.

Relief for the banking sector this morning as Royal Bank of Scotland got its rights issue away successfully. Shareholders snapped up a full 95.1% of the stock for sale in its £12bn offer.

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