By late afternoon, the benchmark S&P/ASX 200 index was up 0.5 per cent to 4006.7; having earlier fallen as much as 220 points to a new intraday two-year low of 3765.9 as the bear market tightened its grip.
"We're seeing a classic 'short covering' relief rally now as traders aggressively look to take profits on their short positions," IG Markets analyst Ben Potter said in a note.
"The Australian market got crunched early morning as wave after wave of forced selling went through the market. Once that subsided, the combination of short covering and bargain hunting has seen a pretty amazing rally.
"Interestingly, however is that other markets have rallied nowhere near as much, with S&P 500 futures only up about 1 per cent from the lows. The other true reflection of safe haven demand, gold continues to power higher, just hitting $US1770.40/oz."
City Index chief market analyst Peter Esho said: "The market gets to a point where it's hard to dismiss value." He add NAB's result, the Chinese inflation data and a speech from US Fed chairman Ben Bernanke tonight had boosted confidence.
Investors also seized on comments by the Reserve Bank of Australia that there were no signs of strains in key money markets, which banks rely on for short-term funding.
"The Reserve Bank is monitoring market developments closely with no strains evident in the money markets. The Reserve Bank's market operations continue to be conducted as usual," a spokeswoman for the central bank told Dow Jones Newswires.
At one stage this morning the benchmark ASX 200 was estimated to have lost about $55 billion.
The uncertainty in global markets sent spot gold prices to a record high of $US1770.54
The Australian dollar had fallen below parity against the greenback to US99.29 cents, taking its losses to nearly 10 per cent since its post-float peak just two weeks ago, but by mid-afternoon it had recovered some lost ground to be just above $US1.
On Wall Street, the Dow Jones Industrial Average sank 634.76 points, or 5.55 per cent, to 10,809.85, for its biggest single-day loss since December 1, 2008 and its sixth biggest points drop on record.
The technology-laden Nasdaq and S&P 500 fared even worse, falling down 6.9 per cent and 6.7 per cent respectively, as traders reacted for the first time to Standard & Poor's historic downgrade of the US's credit rating on the weekend to AA+ from AAA.
Wall St's VIX index, or "fear index", recorded its biggest jump in four and a half years.
The carnage was preceded by sharp falls in Europe, led by Germany down 5 per cent, as the market looked past the European Central Bank's move to calm markets by buying bonds of troubled Italy and Spain.
In the US, the market also largely looked past President Barack Obama saying the world still believed “our credit is AAA". The S&P 500's three-day slide of about 11.2 per cent was the worst since November 2008.
Share market news: France, UK and Japan also face downgrade risk, say Analysts
NEW YORK: Even as the historic credit rating downgrade of the US continues to cause mayhem in global markets, analysts have pointed toward a possible lowering of the ratings for other countries like the UK, France and Japan.
While there is no official word as yet from the ratings agencies -- including S&P, which downgraded the US on Friday -- analysts have said these countries face the significant risk of a credit ratings downgrade in the near future if they do not get their recovery acts together.
The analysts at Brown Brothers Harriman (BBH), a privately held financial services firm offering a range of international investment and banking services, has in fact put out a research note on possible candidates for a downgrade.
The report has named France, Belgium, the UK and Japan at the greatest risk of a downgrade and has said that the US downgrade was unwarranted.
Giving further credence to the chances of a downgrade on Japan, rating agency Moody's yesterday warned that the country's intervention in foreign exchange markets to stop the rise of the yen would be negative for its ratings. In May, Moody's had warned of a possible downgrade of Japan from the current 'AA2' rating.
S&P already has an 'AA-' rating on Japan with a negative outlook.
In its report, BBH said that the UK has been a downgrade candidate for a long time and its weakening growth prospects could trigger a possible lowering of its rating from the 'AAA' level.
About another AAA-rated nation, France, the report said that it has a weaker credit profile than even the US.
Analysts at global investment banking major UBS were also quoted as saying that France was not treated by markets as a AAA country. However, S&P this weekend reaffirmed its 'AAA' rating for France.
On Belgium, the BBH report said that it certainly qualifies for a downgrade, as it has been without a government for more than a year now.
Talking about another European nation, Germany, BBH said that it continues to have a robust AAA-rated credit profile, but the future might not be so bright.
The countries currently enjoying AAA rating include the UK, France, Germany, Austria, Finland, Luxembourg and the Netherlands.
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