LONDON (Reuters) - Global stocks fell sharply and the dollar tumbled on Monday as a fire sale of Bear Stearns and an emergency Federal Reserve cut of a key lending rate sparked fears that a worldwide credit crisis will claim more casualties.

Traders reported that money markets were near standstill with banks increasingly wary of lending to each other.

European shares sank nearly 3.5 percent, following a sell-off in Asia where Japan’s leading indexes shed 3.7 percent. Wall Street looked set for a sharply downward open.

The dollar hit new lows against the euro and a basket six of major currencies. Oil hit a new high of nearly $112 a barrel on the weaker dollar.

Investors dived into safe haven assets, lifting gold to more than $1,030 an ounce at one point and sending yields on short-dated euro zone debt below 3 percent for the first time in more than two years.

“The markets are in a complete state of panic and in such situations there is no such thing as valuation or value in any asset,” said Michael Klawitter, FX strategist at Dresdner Kleinwort in Frankfurt.

In a shock move late on Sunday, the Fed lowered the discount rate it charges on direct loans to banks to 3.25 percent from 3.50 and implemented steps to provide cash to a wider range of financial firms, using tools last used in the Great Depression.

Minutes earlier, JPMorgan Chase & Co had said it would buy Bear Stearns for a rock-bottom price of $2 a share, valuing the U.S. investment bank at the centre of a widening global credit crisis at about $236 million.

JPMorgan and the Federal Reserve Bank of New York temporarily bailed out Bear Stearns on Friday after a deterioration in its liquidity, one the worst cases yet in a broad-based drying up that has been going on since mid-2007.

LIQUIDITY SQUEEZE

Investors are now nearly fully pricing in a 1 percentage point cut in the main federal funds rate at or before the Fed’s policy meeting on Tuesday.

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That would take U.S. rates down to just 2.0 percent.

“Desperate times need desperate measures. The Federal Reserve is doing what it takes to restore stability,” said Craig James, chief equities economist at Commsec in Sydney.

There were also signs of continuing liquidity worries -- three-month interbank lending rates for euro and sterling leapt.

The Bank of England said it would offer 5 billion pounds ($9.85 billion) of three-day funds in an exceptional fine-tuning operation designed to bring overnight interest rates down.

“This action is being taken in response to conditions in the short-term money markets this morning,” the Bank said in a statement.

Market strategists said there was deep distrust between banks when it came to lending.

“It’s quite illiquid this morning. If you want unsecured cash you’re really going to have to pay up for it. It’s really quite an intense situation,” said David Keeble, head of rate strategy at Calyon.

Concern swirled about the problems spreading to other banks. Shares of Lehman Brothers dropped 34 percent in pre-market trading, shares of Merrill Lynch fell 15 percent and Goldman Sachs declined 9.8 percent.

STOCKS, DOLLAR DOWN SHARPLY

Equity markets took a hefty hit across the world as uncertainty grabbed hold of investors.

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“It is really -- and I don’t want to use the broadly quoted word ‘panic’ here -- but it is an absolute confidence crisis and a liquidity crisis. Nobody trusts anyone anymore. It is not a nice situation,” said Roland Hirschmueller, an equities trader at German brokerage Baader in Stuttgart.

European shares tumbled. The FTSEurofirst 300 was down 3.5 percent.

Earlier, Japanese stocks fell to about a 2-1/2 year closing low, dragged down by exporters worried about a rising yen.

The Nikkei average fell 3.7 percent or 454.09 points to end at 11,787.51, its lowest finish since August 8, 2005.

The broader TOPIX index shed 3.7 percent or 43.58 points to 1,149.65, the lowest close since June 2005.

The dollar plunged across the board.

It slid as much as 3 percent in early Monday trading as low as 95.77 yen according to Reuters data, the lowest since 1995, and set fresh all-time lows at 0.9637 Swiss francs.

It later recovered to 96.88 yen and 0.9838 Swiss franc.

The euro soared as high as a new record $1.5904 before dropping back to $1.5774.

The weak dollar drove oil prices higher before it eased back. Crude for April delivery was up 5 cents at $110.28 a barrel, off a record $111.80 hit earlier.

Investors dived into safer assets. Spot gold hit $1,030 an ounce, before falling back to around $1,022 an ounce.

“Gold will be the main beneficiary (of the falling dollar) as a hedge against global risk,” said Australia & New Zealand Bank senior commodities analyst Mark Pervan.

When the U.S. currency falls, the price of gold, like that of oil, tends to rise as investors with dollars buy it to lock in value and non-dollar investors find it cheaper.

Investors also bought bonds. Short-dated euro zone government bond yields were at their lowest in over two years and implied rates down.

The two-year cash yield fell 11 basis points to 2.963 percent, its lowest since early 2006.