World stocks nosedived and demand for safe-haven bonds and currencies soared on Monday as fears gripped investors that a deteriorating U.S. economy would drag others down with it.

MSCI's main world stock index, a benchmark gauge of stock markets globally, sank 2.6 percent, falling below its 2007 bottom to lows last seen in December 2006.

Its emerging market equities counterpart lost more than 5 percent. Meanwhile, the spread between emerging market bond yields and U.S. Treasury yields, a key gauge of risk appetite, was just off its widest in two years.

A mixture of weak global economic data, poor corporate data, increasing fears about the possibility of a recession ... have left investors drowning in a sea of red, said Henk Potts, equity strategist at Barclays Stockbrokers.

The pan-European FTSEurofirst 300 was down 4.2 percent, taking its 2008 year-to-date losses to more than 13 percent.

Japan's benchmark Nikkei average earlier lost 3.86 percent to close at a two-year low and MSCI's main emerging market stocks benchmark was down 3.9 percent.

Risk aversion is widespread as the market thinks (the economic downturn) is not just a U.S. centric story, said Paul Robson, currency strategist at RBS Global Banking.

U.S. stock markets were closed on Monday for a holiday, but U.S. stock index futures were down sharply suggesting investors were not putting much hope on Wall Street leading a rebound when it returns to business.

Investors in Asia and Europe were carrying through from last week's concern on Wall Street that a fiscal stimulus proposed by President George W. Bush would not be enough to stop the U.S. economy from falling into recession.

Bush called for a package worth up to $150 billion in tax cuts and other measures.

Stock markets have been in full retreat this year over the economic fears. The broad U.S. S&P index had its biggest weekly fall since July 2002 last week.

Many indexes are now more than 20 percent below their recent cycle peaks, a traditional sign that what is going on is not just a correction but the start of a bear market.

It's becoming more and more difficult as the market is now in panic, said Hugues Rialan of fund manager Robeco.

RISK AVERSION

Such falls on equity markets sometimes signal to large investors that it is time to buy. But leading investment bank Morgan Stanley said on Monday that was not the case now, at least as far as Europe was concerned.

We are not compelled to buy yet despite bearish sentiment, its European equity strategy team said in a note. We continue to prefer cash over equities.

Recent polls show institutional investors with large cash holdings, a sign of deep concern about the future direction of assets.

The global equity market rout, meanwhile, promoted currency investors to liquidate risky positions, lifting the low-yielding Japanese yen while the dollar gained on the view no country will escape the economic downturn.

The yen rose to a 2-1/2 year high against the dollar before coming back a bit and high-yielding currencies in general sold off.

The dollar was around 0.6 percent weaker against the yen at 106.08 yen. The euro was around 1.5 percent weaker against the yen, below 154 yen for the first time since late August.

The euro was also 0.9 percent down on the day against the dollar at $1.4483, slipping below $1.45 for the first time in a month.

Demand rose for safe-haven government bonds.

The interest rate-sensitive two-year Schatz yield was at 3.355 percent, sinking 10.5 basis points. It is down around 65 basis points so far in January, well on track for its biggest monthly decline in over 10 years, according to Reuters charts.

The 10-year Bund yielded 3.916 percent, down 6.2 basis points.

(Editing by Mike Peacock)

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