THE EURO went into free fall yesterday after Chancellor Angela Merkel warned the single currency was “in danger”.

Hours after her government surprised markets by banning speculative “naked short selling” of shares and some other assets, the euro fell to a four-year low before closing at €1.2247 against the dollar yesterday.

Yesterday morning Dr Merkel defended the move in a Bundestag speech to drum up cross-party support for tomorrow’s vote on the euro zone rescue fund.

“The euro is facing an existential test that it must past,” said Dr Merkel. “To bring matters to the point: the euro is in danger. If we cannot deflect this danger the consequences for Europe and beyond cannot be predicted.”

Germany’s financial regulator, Bafin, surprised markets yesterday by banning naked short-selling on the shares of some 10 leading German financial companies.

Other trades banned involve euro zone sovereign bonds and credit default swaps – a type of insurance – based on these bonds.

In a short sale a traders sells borrowed assets and sells them in expectation of a fall in value, allowing them to buy back the shares and return them to their owner, with the trader keeping the profit.

In a naked short sale the trader never even borrows the assets, meaning their bets are unlimited.

All but one of the companies affected by the ban fell in trading yesterday. Deutsche Bank, Commerzbank and Allianz, as well as the German Stock Market and reinsurance giant Munich Re, were all down between 2 and 4 per cent in trading.

A Deutsche Bank spokesman declined to comment directly on the ban, saying only: “The markets speak for themselves”.

The German regulator said the ban was prompted by “massive” short-selling and by excessive price swings which “could endanger the stability of the entire financial system”.

A finance ministry spokesman said the German government was confident it had “picked the right moment” for the emergency ban, which as yet has no under-pinning law.

As a result of this, many leading analysts were highly critical of Berlin’s ban, calling it vague and imprecise. “The German solo run shows that, once again, Europe is not speaking with one voice,” said Özgör Atasever of the private Metzler Bank.

“This leaves investors feeling insecure and leads to finances being pulled out of the euro zone.”

Berlin shrugged off negative remarks, pointing to positive reaction from the European Commission and France’s existing ban on naked short selling.

Dr Merkel’s European colleagues were, meanwhile, scrambling to restore unity as they reeled from lack of notice about the ban. Officials in Brussels, Paris and other EU capitals made little effort to disguise their surprise and irritation at the German move.

Most saw the step as motivated by domestic political pressure.

France was particularly critical . Finance minister Christine Lagarde said Berlin should have talked to other governments first.

Germany’s move could cut liquidity in debt markets, particularly for states with big fiscal problems, she said.

Finance ministers meet in Brussels tomorrow to try to agree on how to stabilise the 16-nation euro zone and reform its economic governance.

EU internal market commissioner Michel Barnier said: “It is important that member states act together and that we design a European regime to avoid regulatory arbitrage and fragmentation both within the EU and globally.” – (Additional reporting: Copyright The Financial Times Limited 2010)