Share prices tumbled in London as traders feared that the Monetary Policy Committee's bold move could reflect hidden difficulties in the financial system.
Sentiment was further undermined by a raft of grim economic news showing weaker manufacturing output and retail sales in October.
The FTSE 100 index ended the day down 143.1 points at 5,479.8, while the interest-rate cut also hit sterling, which was down almost a pfennig against the Deutschmark to close at DM2.756.
Neil Parker at Royal Bank of Scotland said: "There has been some speculation along the lines of: `What do they [the Bank] know that we don't?'".
New figures showing falling manufacturing output and retail sales, combined with several disappointing earnings announcements from leading UK companies, also contributed to the FTSE's slide.
Mr Parker said: "There is a crisis of confidence and manufacturers simply aren't selling enough."
A weaker-than-expected start to trading on Wall Street did not help UK market gloom. The Dow opened down 50 points, but later rebounded after encouraging remarks from Alan Greenspan, chairman of the US Federal Reserve. The Dow closed up 132.2 points at 8,915.47.
Mr Greenspan suggested there was some evidence of an easing of US credit conditions. Worries about a credit crunch - which occurs when credit is denied to financially sound institutions - played an important part in the Fed's recent decision to cut interest rates twice within the space of a fortnight.
Analysts speculated that evidence of tightening credit conditions in the UK could have been one factor in the Bank's decision to cut rates by 0.5 points. The Bank recently commissioned its regional agents to carry out a survey of local credit conditions.
In a statement released together with its decision on interest rates, the MPC said: "News about the international environment and the prospects for domestic activity have led the Committee to moderate its forecast for growth next year."
Michael Saunders, of Salomon Smith Barney, said: "The statement does not say that the MPC is reacting to a deterioration in borrowing conditions, although it is possible that this is a part of their worries about domestic activity."
New data showing falling manufacturing output and retail sales backed up the Bank of England's decision to plump for a 0.5-point cut rather than a quarter-point reduction, analysts said.
Figures from the Office for National Statistics revealed that industrial production fell by 0.6 per cent in September, while manufacturing output fell by 0.1 per cent in the third quarter of the year.
Adam Cole at HSBC Securities said: "The marginal fall in manufacturing output in the third quarter is almost certainly the beginning of a more marked downturn."
The Confederation of British Industry (CBI) announced that retail sales were on the whole lower in October 1998 than in October 1997.
According to the latest CBI distributive trades survey, 32 per cent of retailers said their sales were higher than a year ago, compared with 36 per cent saying they were lower. This gives a net balance of 4 per cent of retailers reporting a downturn.
Alastair Eperon of the CBI said: "The survey continues to suggest that underlying growth in retail trade is losing momentum."
Meanwhile, sales of new cars fell by 0.9 per cent last month compared with sales in October 1997, according to released by the Society of Motor Manufacturers and Traders.