The pound also slipped further after an unexpectedly sharp rise in German import prices suggested the Bundesbank would tighten monetary policy. The continuation of Thursday's slide in the value of sterling also reflected a forecast from the Confederation of British Industry (CBI) earlier in the week that UK interest rates have moved high enough to restrain inflation.
The FTSE 100 index of leading shares was down more than 110 points at one stage on the back of another poor showing from Wall Street, which reacted to fears that economic growth is too strong. London finally closed 76.9 lower at 4,901.1 while a late rally in New York saw the Dow Jones Industrial Average recoup most of a 170-point fall to end down just 9.06 at 7,884.89.
Dealers said the fall in London was exaggerated by low trading volumes. They added that investors were trying to pre-empt any slump in New York on Monday when the market will be closed for the bank holiday.
One of the few bright spots in the leading index was provided by BT, which closed 23.5p higher at 436p after it agreed to reduce the price it would pay for MCI by as much as 22 per cent, so salvaging the world's largest telecommunications takeover.
Smaller companies again did better, boosted in part by the weakness of the pound and by a growing belief that the second-liners represent much better value than the leading stocks that have led the market higher so far this year. The FTSE 250 index closed 29.3 points lower at 4,658.7.
A rise in German rates as a result of higher prices would narrow the gap between the two countries' base rates, making the pound, which closed yesterday at DM2.91, relatively less attractive. German import prices surged 0.6 per cent in July and 4.2 per cent over the past year, well above analysts' forecasts of 0.2 and 3.7 per cent.
German prices were boosted in July by the strength of the dollar, which appreciated by 3.7 per cent against the mark, and by higher oil prices, which rose by 4.3 per cent on average. Together with recent comments in the Bundesbank's monthly inflation report, the data raised fears that the central bank is poised to take a more hawkish line on inflation.
Other data yesterday showed a resurgence of manufacturing investment by British companies - in the second quarter of the year it was running 26 per cent higher than a year earlier. Economists said the increase was "staggering", showing that companies were reacting to competitive pressures and difficult trading conditions by raising investment rather than cutting it.
Kevin Darlington, an economist at ABN Amro Hoare Govett, said the figures showed that business investment had been much more resilient than headline figures earlier in the week implied.
The Office for National Statistics also issued motor vehicle production figures yesterday, showing the seasonally adjusted total car production index fell from 126 in June to 122 in July. In the six months ending in July, production fell by 7.9 per cent against the previous six months.