The FT-SE 100 index closed just over 36 points lower at 3,704.2, while gilts fell half a point. The pound lost more than half a pfennig to end at DM2.2284.
Other European bond and stock markets, including Milan, Paris and Frankfurt, also ended lower after a 50-point drop in the Dow Jones to 5580.5 by mid-morning triggered the New York Stock Exchange's curbs on computer- driven trading. The dive in share prices followed a decline in US Treasury bonds, with the yield on the benchmark 30-year bond approaching 6.5 per cent for the first time since September.
Analysts blamed the prospect that the Government might have to face a confidence vote after last night's debate for part of yesterday's gloom.
Chris Turner, currency analyst at BZW, said: ``Politics will cast a shadow over the pound until the general election.'' He said foreign exchange dealers were concerned yesterday that sterling might dive in Asian markets after the Scott vote if the Government lost.
Jonathan Loynes, an analyst at HSBC Markets, said: ``Political risk makes the UK unattractive compared to other markets.'' But he added that investors had been taking account of the political situation for some months, explaining why London has underperformed since early last year.
Share prices in London have been falling for most of February. The FT- SE 100 index was last night barely above its new year level of 3689.3.
Analysts said the declines in US shares and bonds in morning trading were to blame for the Europe-wide weakness. Bijal Shah, equity strategist at Merrill Lynch, said: ``This is a contagion spreading from the US to other markets.''
US bonds and shares were sharply lower in the latest of several days of volatile trading. Investors were nervous ahead of figures today for US producer prices and tomorrow for consumer prices in January, fearing that markets might have been over-optimistic about how much further interest rates can fall. The change in sentiment during the past two weeks has raised the yield on Treasury bonds by nearly half a point.
A recommendation yesterday from Dean Witter Reynolds, a top Wall Street broker, that clients should cut their holdings of bonds and shares in favour of cash, spurred the fall in the financial markets. The advice followed a similar move last week by Morgan Stanley.