Fresh credit worries hit FTSE; Smith & Nephew up

* FTSE 100 falls 1.1 pct * Fears of Fannie Mae, Freddie Mac bailout hit financials * Bid speculation on Zimmer Holdings lifts Smith & Nephew

By Dominic Lau

LONDON, Aug 19 (Reuters) - Britain's leading share index fell for the third session in a row by midday on Tuesday to stand down 1.1 percent as fears of fresh credit losses weighed on banks.

By 1029 GMT, the FTSE 100 .FTSE was down 59.3 points at 5,390.6. The UK benchmark is down 16.5 percent for the year.

Wall Street tumbled overnight and shares of Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) fell to their lowest in nearly 20 years after Barron's said the government may have no choice but to nationalise the two housing finance groups. This could wipe out existing holders of the two companies' common stock and result in losses for other asset holders.

Former IMF chief economist Kenneth Rogoff said the worst of the global financial crisis is yet to come and a large U.S. bank would fail in the next few months as the world's biggest economy hits further troubles. [ID:nSP216950]

"A lot of people have thought over the course of last few weeks that much of the bad news regarding markets is out in the public domain. That clearly is not the case," said Peter Dixon, UK economist at Commerzbank.

"We saw the comments from Rogoff, suggesting that a major U.S. bank could well go under. That just reawakens investors to the idea that we are by no means over the worst of the crisis."

Banks shaved nearly 37 points off the FTSE 100, with Barclays (BARC.L: Quote, Profile, Research, Stock Buzz), Royal Bank of Scotland (RBS.L: Quote, Profile, Research, Stock Buzz), HSBC (HSBA.L: Quote, Profile, Research, Stock Buzz), HBOS (HBOS.L: Quote, Profile, Research, Stock Buzz), Lloyds TSB (LLOY.L: Quote, Profile, Research, Stock Buzz) and Standard Chartered (STAN.L: Quote, Profile, Research, Stock Buzz) down 3.4 to 5.4 percent.

Insurers were hurt by the knock-on effect, with Standard Life (SL.L: Quote, Profile, Research, Stock Buzz), Old Mutual (OML.L: Quote, Profile, Research, Stock Buzz), Prudential (PRU.L: Quote, Profile, Research, Stock Buzz), Aviva (AV.L: Quote, Profile, Research, Stock Buzz) and Friends Provident (FP.L: Quote, Profile, Research, Stock Buzz) losing between 1.9 and 4.2 percent.

"The widening in U.S. Libor ... is very significant because it suggests that banks are under pressure to finance debt that they have to repay by the end of the year," said Jeremy Batstone-Carr, head of private client research at Charles Stanley. "Certainly, judging by the data that I have seen, the numbers are enormous, which is going to leave the banks very constrained. The credit crisis is going to keep on claiming victims throughout the remainder of the year."

The spread of London interbank offered rates over overnight index swap rates widened on Monday. The spread expresses the premium paid for borrowing over anticipated central bank rates, and a wider spread is seen as an indication of a decreased inclination to lend.

Batstone-Carr said central banks should give up their fight against inflation and focus on shoring up growth and tackling the crisis in the financial sector.

Bid speculation on U.S. orthopaedic device maker Zimmer Holdings (ZMH.N: Quote, Profile, Research, Stock Buzz) lifted Smith & Nephew (SN.L: Quote, Profile, Research, Stock Buzz) 3.2 percent to top the FTSE 100 gainers, traders said.

Gas producer BG Group (BG.L: Quote, Profile, Research, Stock Buzz) strengthened 1.7 percent as Australia's Origin Energy (ORG.AX: Quote, Profile, Research, Stock Buzz) reiterated that its shareholders should reject the British firm's $11.9 billion hostile takeover bid.

Vodafone (VOD.L: Quote, Profile, Research, Stock Buzz) shed 1.1 percent after the Financial Times said the mobile phone giant is to increase its minimum British call charges from September by at least 25 percent and by as much as 50 percent for some customers. (Editing by Paul Bolding)