The FTSE 100 was one of the biggest casualties, suffering its biggest points fall in more than three years. World markets were also hurt by the falling value of the US dollar, which hit its lowest level for a year against the pound and euro.
The rout was triggered by a slump on Wall Street, where the Dow suffered its worst fall for five months on Thursday night.
The FTSE 100 closed down 129.9 points at 5,912.1, a fall of 2.15 per cent - the biggest one-day fall for almost exactly two years in percentage terms. The last time there was a bigger points fall was 12 March 2003, when it lost 165.7.
The sell-off travelled around the world, with Tokyo and Hong Kong suffering losses of about 1.5 per cent before the rout reached the shores of Europe.
"Inflation is a big concern," Peter Dunay, the chief investment strategist at Leeb's Index Trader in New York, said. "The more we see, the more concerned investors will be about how the Fed is going to react to that."
The FTSE 100 suffered from its strong weighting towards US earnings, particularly its pharmaceuticals, financial services, industrial and mining sectors. Dollar earners such as Amvescap, the fund manager, and Wolseley, the world's biggest plumbing group, fell, as did miners such as BHP Billiton, Anglo American and Rio Tinto.
The US dollar has lost about 6 per cent in trade-weighted terms and 8 per cent against the euro and sterling. Yesterday it came within a whisker of falling through the $1.30 barrier against the single European currency and $1.90 against the pound.
Sterling was boosted after David Walton, a member of the Bank of England's Monetary Policy Committee, said the UK had emerged from its soft patch. "I think we have more confidence, that the recovery is established, and that the economy will continue to grow at close to its target," he told The Northern Echo.
His comments came two days after the Bank published inflation forecasts that appeared to point to the need for a rate rise.
Geoff Kendrick, the currency strategist at Westpac, said:"There is the fact the dollar is in a whole lot of trouble and also the data continues to do pretty well in the UK, so the chances of a hike from the Bank of England at some stage are starting to pick up."
The dollar continued to fall despite an unexpected narrowing in the US trade deficit in March as exports climbed to a record high. The shortfall narrowed for the second month in a row, to $62bn from February's $65.6bn. However, the breakdown of the data showed the bilateral trade deficit with China deteriorated to $15.6bn from $13.8bn in February.
The dollar was also hit by fresh selling after a key index of US consumer optimism fell in May to its lowest since Hurricane Katrina, hit by $3-a-gallon gasoline, rising mortgage interest rates and a souring political climate.
Meanwhile, commodity prices fell after their runaway rally on Thursday that saw several base metals hit all-time record levels.Reuse content