The weaker pound capped losses on London's benchmark FTSE 100 index

London (AFP) - European stock markets slumped Friday and the pound hit a fresh two-year low against the euro as traders reacted to a fast-moving Italian political crisis and data showing Britain’s Brexit-facing economy is on the brink of recession.

“Markets tumbled on Italian political risk,” said Craig Erlam, senior market analyst at Oanda trading group.

Wall Street followed suit, opening solidly down as the US-China trade war continues to dampen investor enthusiasm.

Milan’s stock market sank more than two percent after Italy’s far-right Deputy Prime Minister Matteo Salvini pulled his support for the country’s coalition government on Thursday and called for snap elections.

The heightened political tensions in the heavily-indebted country – the eurozone’s third largest economy – also caused yields to rise on Italian government bonds.

“Naturally, Italian stocks – and in particular, banks – and bonds have been hardest hit but they are dragging everyone else down with them,” Erlam said.

In currency trading, sterling’s woes helped propel the European single currency to a two-year high at 92.72 pence.

The weaker pound capped losses on London’s benchmark FTSE 100 index that features numerous multinationals earning in dollars.

Adding to Britain’s economic troubles, official data released Friday showed the country’s gross domestic product (GDP) fell 0.2 percent in the second quarter, the first time it has contracted in almost seven years.

Another contraction in the third quarter would put Britain in an official recession, ahead of the nation’s expected withdrawal from the EU on October 31.

“All in all, today’s disappointing GDP figure is set to raise alarm bells over Brexit dragging the UK economy deeper into the abyss,” said Lukman Otunuga, senior research analyst at FXTM.

“This unfavourable scenario may prompt the Bank of England to cut interest rates sooner than anticipated, in an effort to revive the UK economy.”

- Volatile week -

Elsewhere, Frankfurt’s DAX 30 index sank one percent after data showed German exports in June were eight percent lower than last year, just the latest poor economic indicator for the country.

In Asia, stock markets largely reversed early gains from a bargain-hunting push as investors remained cautious over the US-China trade war.

Equities largely advanced on bargain-hunting by investors after several days of losses

Tokyo managed to hold on to its winnings after figures showed that Japan, the world’s third-biggest economy, was growing faster than predicted.

In a volatile week for markets, equities were hammered Monday after Beijing allowed the yuan to slide sharply against the dollar following US President Donald Trump’s announcement of fresh tariffs on Chinese goods starting September 1.

Safe haven assets such as bonds, gold and the yen remained in demand on Friday, signalling that trade war fears would continue to weigh on markets.

Oil prices surged despite the International Energy Agency lowering its growth forecast for demand over concerns about the health of the global economy.

- Key figures around 1355 GMT -

Milan - FTSE MIB - DOWN 2.2 percent at 20,376.38 points

London - FTSE 100: DOWN 0.1 percent at 7,280.82 points

Frankfurt - DAX 30: DOWN 1.0 percent at 11,725.11

Paris - CAC 40: DOWN 0.8 percent at 5,346.87

EURO STOXX 50: DOWN 1.0 percent at 3,342.80

New York - Dow: DOWN 0.4 percent at 26,275.82

Tokyo - Nikkei 225: UP 0.4 percent at 20,684.82 (close)

Hong Kong - Hang Seng: DOWN 0.7 percent at 25,939.30 (close)

Shanghai - Composite: DOWN 0.7 percent at 2,774.75 (close)

Euro/pound UP at 92.75 pence from 92.15 pence around 2100 GMT

Pound/dollar: DOWN at $1.2069 from $1.2138

Euro/pound: UP at 92.72 pence from 92.12 pence

Euro/dollar: UP at $1.1195 from $1.1182

Dollar/yen: DOWN at 105.79 yen from 106.06 yen

Brent North Sea crude: UP $1.57 cents at $58.95 per barrel

West Texas Intermediate: UP $1.96 cents at $54.50 per barrel