Financial markets reversed on Tuesday amid concerns that Asian central banks were diversifying out of US dollar assetsand that demand for oil would remain persistently strong.

The dollar fell sharply in foreign exchange markets, crude oil prices jumped back above $50 a barrel and stock prices declined worldwide, bringing an unwelcome shock to investors.

The dollar suffered its biggest fall since October as South Korea said it would diversify the currencies in which it holds its $200bn of foreign exchange reserves, up to 90 per cent of which may be in dollar-denominated assets.

The move reignited fears that Asian central banks may be losing their appetite for the dollar at a time when the US needs to attract $2bn of foreign capital a day to cover its current account deficit.

The dollar lost much of the ground it had gained in 2005, falling 1.3 per cent against both the euro and yen to $1.323 and Y104.10 respectively, as well as sliding 1.8 per cent to a seven-year low of Won1,005 against the South Korean currency.

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Gold shares rose, as April gold futures surged by $7.40 to close at $435.80 an ounce in New York.

The dollar movements were triggered by a parliamentary report from the Bank of Korea that said it would increase investments in high-yielding non-government debt, such as papers issued by financial institutions and asset-backed securities, and diversify its holdings into a variety of currencies.

"We have already been reducing the portion of dollar-denominated assets while increasing that of non-dollar assets. And we will continue to do so gradually," said a BoK official. "It's a global trend that central banks diversify into non-government papers as their reserves increase." The move follows similar announcements from Thailand, Taiwan and Indonesia. It reflects Asian governments' increasing concern that a falling dollar could reduce their reserves unless they diversify their currency holdings.

The US dollar clawed back a fraction of Tuesday’s sharp losses in European trade on Wednesday as South Korea clarified its plans to diversify its foreign exchange reserves and Japan said it had no plans to sell dollars.

The Bank of Korea had precipitated Tuesday’s dollar sell-off when it said it planned to diversify its $200bn of reserves, between 70 and 90 per cent of which are estimated to be in dollar-denominated assets.

However the BoK said in a statement on Wednesday that it was looking to invest more in non-government bonds and that it would not sell “current” dollar holdings for other currencies.

This, of course still left room for Seoul to re-direct new reserves away from the dollar. “This would seem to us to indicate that the BoK was specifically talking about diversifying any additional reserves that it might accrue through the coming fiscal year rather than the reserves it has already built up,” said Simon Derrick, head of currency research at Bank of New York.