In London, the FT-SE 100 Index fell by 51.5 points to close at 2,431.9, the steepest daily fall since the Budget on 10 March.
Shares were also depressed by a surprise 0.24-point increase in the mortgage rate by Cheltenham & Gloucester Building Society, even though other societies made it clear that they would not immediately follow suit.
On Wall Street, worries over poorer-than-expected results from IBM pushed the Dow Jones Industrial Average down by nearly 30 points to 3,331 by the close.
Reflecting worries over a prolonged period of high rates, the pound fell 1.53 pfennigs to DM2.8487. The dollar sank even more sharply, by 1.94 pfennigs to DM1.4593, because of the widening gap between high German and low US rates.
Contributing to the gloom in London was the continuing uncertainty over German interest rates after the Bundesbank on Thursday raised its discount rate to 8.75 per cent, the highest since 1931.
Fears persist that the Bundesbank might act again in the autumn, forcing the Bank of England to raise base rates.
In the money markets, the three-month interbank rate edged up to 10 1/4 per cent, indicating market concerns over a possible rise in European rates. 'Investors hate uncertainty,' Roger Palmer, equity strategist with Kleinwort Benson, said. 'There's just no ray of sunshine anywhere.'
C&G, the country's sixth-largest building society with 330,000 borrowers, said it was raising its standard mortgage rate from 10.75 per cent to 10.99 per cent. The rate applies to new and existing borrowers from today.
All building society mortgage rates are under pressure because they are having difficulty maintaining savers' deposits in the face of renewed competition from National Savings, fuelled by the ballooning budget deficit. Margins have already been cut to the bone and they see little room to raise savers' rates without increasing returns on mortgages.
Andrew Longhurst, chief executive of C&G, said: 'The Government has pitched high street interest rates at a new level with its latest National Savings account and C&G cannot allow its own investors to be left behind. Our move is a defensive one, designed to retain existing investors' funds, which are committed to home buyers.'
C&G was under more pressure than most to raise its rate because it had been undercutting its competitors for most of the year. It set its rate at 10.75 per cent for new borrowers in January and for existing ones from April.
Most societies did not bring their rates down to this level until May for new borrowers and the beginning of this month for existing borrowers.
C&G saw the increase as inevitable once it decided to compete head-on with the new National Savings First Option Bond.
This was launched on 7 July, and had attracted pounds 112m by Thursday evening. New figures from National Savings show that it contributed a net pounds 439m to government funding in June against pounds 147m in the same month last year. C&G has launched a new fixed-rate bond to compete with First Option, offering a slightly higher rate of interest on amounts up to pounds 20,000.
Other large building societies and Abbey National said they had no immediate plans to follow C&G, but all will be looking closely at their rates in the next week.
The failure of a strong recovery to show up in either corporate results or US trade figures caused New York share prices to fall sharply.
The market was discouraged by news that the US trade deficit had widened to dollars 7.38bn in May from dollars 7.06bn the month before, with exports falling almost twice as fast as imports. The gap for the year so far is dollars 29.1bn, compared with dollars 25.8bn in the same period last year.
The New York markets, which rallied on Thursday after the news that Ross Perot had decided to abandon his independent bid for the US presidency, were rattled briefly by an unsubstantiated rumour that the US President, George Bush, planned to withdraw from the race because of health problems.
The White House issued a pointed denial and said Mr Bush would make a scheduled public appearance later in the day.
Money, page 20Reuse content