The FT-SE index of 100 leading London shares fell 63.4 points to close at 3,085.6, its lowest in more than four weeks. The fall wiped nearly pounds 10bn off the value of the market. The gilts market had its worst day since the August retail price index fuelled worries of a resurgence in British inflation.
The 2.01 per cent fall in London share prices was slightly more modest than in most other European markets. The German market fell by 2.4 per cent, the French by 2.07 per cent and the Dutch by 2.3 per cent. On Wall Street, however, bargain- hunters drove the Dow Jones average 18 points higher following two days of sharp falls.
Falls in US Treasury bond prices hit the prices of long-dated British gilts, while short-dated stock remained buoyed by hopes of a cut in British base rates around the time of the Budget at the end of the month. Bond markets around Europe also suffered.
The announcement of an unexpectedly strong rise in non-farm employment in the US last month added to the conviction that the US recovery is strengthening significantly and that the Federal Reserve may be forced to tighten policy as inflation begins to gather strength.
Fears of a rate rise pushed US Treasury bond prices lower, with the yield of the 30-year benchmark bond rising to 6.25 per cent after the jobs figures were released. The merest whiff of higher inflation may mean the death knell for the market's year-long rally.
Higher US interest rates mean investors are more likely to keep funds in the US than in Europe.
After months in the doldrums, the gathering US economic recovery is starting to create new manufacturing jobs, suggesting that growth is now running at a solid 3 per cent-plus but increasing the markets' conviction that the long- feared upturn in interest rates may finally be at hand.
The overall jobless rate edged up to 6.8 from 6.7 per cent in September, but total payrolls grew by 177,000, far above most economists' expectations, according to the Labor Department. Most heartening of all, factory jobs increased by 12,000, the first rise since February.
The unemployment data were the latest of a string of indicators suggesting the economy has entered a period of steady if unspectacular growth. The picture emerging over the past week is of sharply improving productivity, expanding factory order books and record activity in the new housing sector as buyers have moved to take advantage of historically low mortgage rates. Consumer confidence is also gingerly recovering after a sharp decline during the summer.
Black spots do remain. According to the Labor Department, the unemployment rate rose from 9.4 to 9.8 per cent in recession-mired California, with similar big increases in other states such as New York and Texas.
The consensus is that growth may now be running at 4 per cent, with every prospect it will stay at 3 per cent or more throughout 1994. But the message should be, 'Stand pat, inflation is a non-problem and you're doing fine,' said Robert Dederick, a Chicago investment economist.
Even the slight worsening of the overall jobless rate in October is being taken as good news for the economy and thus a bad omen for bond prices. Labor Department officials said brighter job prospects might have drawn back into the labour market people who had previously made no effort to seek employment.
Events in the US Treasury market overshadowed the announcement of a sharp rise last month in German unemployment, with economists saying many more jobs would be lost even after the economy began to recover next year.
The Federal Labour Office said unemployment in western Germany rose by nearly 70,800 to 2.36 million. The unemployment rate went up to 7.6 from 7.4 per cent in September. In eastern Germany unemployment rose by 6,000 to 1.17 million, a rate of 15.3 per cent.