The FTSE 100 index closed below the psychologically important 5,000 barrier on worries over the broadcast of the videotapes of President Clinton's testimony to the Grand Jury, as well as the outlook for world growth.
The FTSE hit a low of 4,899.6 - a fall of 156 points - in the early afternoon, but staged a partial recovery after the broadcast of the tapes, which were not as damaging as some analysts had feared. The index closed at 4,990.3, down 65.3 points on the day, and 19.2 per cent lower than its all-time high of 6,179 reached on 20 July.
The market slide came as Mr Blair, in a speech to the New York Stock Exchange, stressed the need for an overhaul of the World Bank and the IMF, and said the international community should aim to complete the reformswithin a year. He called for greater transparency both from governments and from international financial institutions.
Mr Blair said there was a need to recognise the degree of interdependence between economies, and said that the current crisis illustrated the weakness of the existing international financial system.
His comments came as the IMF, in its annual report on capital markets, warned that unless Japan acts to shore up its banking system and stimulate its economy, a new round of Asian devaluations could be on the cards. The IMF concluded that there were "significant risks and uncertainties" in international capital markets.
The IMF's view that the debt-ridden Japanese banking sector posed a major threat to the region's stability was underlined by yesterday's falls in Far Eastern equity markets.
On the Clinton videotapes, one analyst said: "The markets are looking for him [Clinton] to lose his composure. He hasn't yet and, so far, there's nothing new from the content of the testimony."
Wall Street followed a similar pattern to London. The Dow was down more than 180 points in early trade, but then made up the lost ground during the transmission of the tapes. The index finally regained all its losses, ending up 37.59 at 7,933.25.
In Hong Kong, the Hang Seng closed down 275.73 points at 7,170.23, while in Japan the Nikkei hit a 12-year-low of 13,597.30, down 385.82, after cracks began to appear in the compromise on banking reform hammered out by Japanese politicians on Friday.
After the Nikkei closed, Fitch IBCA, a leading credit rating agency, downgraded the Japanese long-term foreign currency rating from AAA to AA+, dealing a further blow to investor confidence about the country's economic prospects.
Marian Bell at the Royal Bank of Scotland said: "It's been a global financial fallout. There's been a credit downgrade for Japan, the apparent collapse of the banking deal and the Clinton tapes. I think we're looking at a global financial collapse and the lack of US leadership isn't helping."
In Frankfurt, the DAX Xetra closed down by almost 4 per cent at 4,439.13, and in Paris the CAC-40 finished the day down 3.5 per cent at 3,342.65. The Russian stock market closed down 4.6 per cent at 47.81, a record low, and currency trading was suspended after fragile market sentiment was dented further by the central bank's decision to print money. In Brazil, the Bovespa index closed down 3.9 per cent at 6,450.
Bonds were once again the main beneficiary of the turmoil in the equity markets. Liffe's December gilt future closed at 115.55, up 0.54.
Outlook, page 17
Hamish McRae, page 19
Leading article, Review page 3