By the close, the FT-SE 100 had fallen by 52.1 points to 2,370.0, almost wiping out a 51.2 point rise on Monday after the German Bundesbank cut short-term interest rates.
But dealers said that the volume of share dealing in London - 507.3 million trades - was low in relation to the size of the movement in the market. This suggested that market makers had cut prices aggressively to protect their book positions. Many said that the combination of volatility and subdued volume would continue in the run-up to the French referendum this weekend.
Evidence that the 7 per cent devaluation of the Italian lira and the small cut in German rates had failed to relieve currency tensions within the exchange rate mechanism turned the speculative tide against sterling.
By the close the pound had fallen 2.95 pfennigs to DM2.7842, only slightly above its allowed ERM floor price of DM2.7780. In the process short-term money market rates rose to levels which, if maintained, would lead to a rise in the bank base lending rate, currently 10 per cent.
In the London interbank market one-month and three-month money was bid up by 0.5 percentage points. The offered rate on three-month money closed at 10.75 per cent, which would be compatible with a full one-point rise in bank base lending rates.
Government bonds retreated by pounds 1 and the yield on 11.75 per cent Treasury 2003/7, a benchmark issue, rose to 9.5 per cent.
Stock market morale also suffered from a poor showing on Wall Street where the Dow Jones average was down almost 49 points by the close of trading. .
Hopes that the moves on the lira and German interest rates would solve the crisis were dashed as the Italian currency came under renewed pressure. This was seen as ruling out the chance of a cut in Italian interest rates and dealt a sharp blow to Italian government bond prices and shares.
Another factor in London stock market nerves was an unexpected cut in interim dividend by the paper maker Arjo Wiggins and a forecast reduction in its final. Arjo shares plunged by 53p to 129p.
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