Unexpectedly strong industrial production figures in Germany reignited fears that German rate cuts were drawing to a close - even though some Bundesbank officials stated that they would resume later in the year.
And a larger-than-forecast surge in US factory gate prices dashed hopes that the Federal Reserve had put interest rate increases on hold. Several analysts forecast a series of quarter-point rate-hikes starting in July or August.
The FT-SE 100 index of leading UK shares tumbled 38.6 points to 2,931.9, its lowest point since 30 July last year. The index has fallen almost 200 points since the start of last week. Wall Street fared better and the Dow Jones Average gained 2.46 at 3,760.83 as the bond market recouped heavy losses.
In France, the CAC-40 index finished below 2,000 points for the first time since 28 July last year, to end at 1,979.68, a loss of 2.47 per cent on the day.
World bond markets were described as extremely fragile after gilts slumped by more than a full point and pushed the long gilt future to a new contract low.
In Germany, bund yields broke through the important 7 per cent level for the first time in more than a year after prices fell by over half a point. US Treasury bonds also fell about half a point, reacting to a surge in factory gate prices as measured by the highly regarded National Association of Purchasing Managers.
The NAPM price index shot up to 71.5 in May from 63.2 in the previous month according to the latest survey of US manufacturing industry. The production index steadied at 57.7, indicating continued strong growth in May and resulting in the biggest rise in manufacturing employment since late 1988.
In Western Germany, strong industrial output data for April provided further evidence that the economy is pulling out of recession. The Economics Ministry said April output was 2.5 per cent higher than March, and 4.1 per cent above its level in April 1993. Economists expect the April figure to be revised downward by about 1 per cent, but it will still be the third month in a row of rising output.
The markets largely ignored a slight drop in the German repo rate. That was cut to 5.15 per cent from 5.20 per cent.
Some Bundesbank officials said the cycle of key rate reductions had not ended. Confirming that monetary policy is on hold for the moment, while the central bank watches developments in M3 money supply, the officials held out the prospect of further rate cuts later this year. 'A definite end of the monetary easing has by no means been indicated and has certainly not been agreed on,' said Olaf Sievert, president of the central bank of the states of Saxony and Thuringia.
But another Bundesbank council member, Guntram Palm, said the latest cuts in the Lombard and discount rates meant there would be a halt in rate cuts for now. He said he believed the trend to lower rates could even be drawing to a close.
Analysts said the European market declines amounted to a gross overreaction when measured against firm evidence of inflation pressures.