The UK's blue-chip FTSE 100 index fell by over 100 points, knocking nearly pounds 20bn from the value of the country's largest companies.
"It looks as if Asia could cause world economic slowdown", said Trevor Greetham, global strategist at Merrill Lynch.
Negative market sentiment began on Tuesday in New York, where the Dow Jones finished down 150 points amid jitters over blue-chip corporate earnings. Stocks slid further when the Far East markets opened for business with Hong Kong - now predicted to enter recession for the first time since 1985 - worst hit.
Hong Kong's blue chip Hang Seng Index tumbled below the psychologically important 9,000 mark as share prices fell by 5.3 per cent, or 498 points.
When London opened for business yesterday morning, shares fell by more than 95 points - about 1.5 per cent - in the first 30 minutes. The FTSE continued to fall, touching an all-day low of 5836.9 in mid-afternoon, before recouping some of its earlier losses and finishing at 5870.2, down 100.5 points, or 1.7 per cent.
Companies with significant Asian concerns were affected most. HSBC, the banking giant which owns the UK's Midland Bank, was one of the worst hit. HSBC finished the day at 1531p, down over 100p. Standard Chartered, the London-based international banking group, finished down 40.5p at 772p.
Wall Street moved sharply lower - down around 150 points at one stage yesterday - but mounted a rapid late-session recovery to end mixed as investors showed their bargain-hunting prowess to stunning effect. The Dow ended off just 27 points at 8936.57. Nasdaq, worst hit for much of the session, ended up 3.21 points at 1781.30 as bargain-hunters favoured computer stocks.
Mr Greetham said: "Bond markets are doing well, and equity markets are suffering. That is usually a sign that the world economy is contracting."
In Hong Kong, where traders were poised for further falls today, investors were taken aback by a statement made by Tung Chee-hwa, Hong Kong's chief executive, on Tuesday night. Mr Chee-hwa told foreign correspondents that growth in the region would "fall substantially and indeed may even be negative".
Howard Georges, the vice-chairman of the South China Securities broking house, said: "This comment came out of the blue. He didn't seem to offer any hope about the economy".
Mr Tung's statement also flatly contradicted a speech the previous week by Sir Donald Tsang in which he insisted that he had no data to support a lowering of the government's 3.5 per cent economic growth estimate for 1998. However first quarter economic growth figures will be released tomorrow which could show that the economy has gone into recession for the first time since 1985.
Yesterday Sir Donald said: "We already had a very rough last quarter in the end of 1997, we are having a very rough quarter in the first part of 1998 as well - we have to face up to these realities".
The government's economic growth forecasts are now entirely out of line with almost all private sector estimates. Yesterday HSBC Securities lowered its 1998 growth forecast from 2 to 1 per cent. Two finance houses, J.P.Morgan and Daiwa, are already forecasting negative growth.
The OECD predicts that the economy will expand by no more than 0.9 per cent. Even the most optimistic forecast, from Bank of America, is 0.5 per cent lower than the official figure.
On top of the gloom about economic growth figures, pessimism was fuelled in Hong Kong by the release of retail sales figures for March showing a 13 per cent downturn as unemployment rose to a 14-year high of 3.9 per cent.
Meanwhile, in the all-important property market which underpins the stock exchange, there were indicators of a further slump in business when figures were released showing a near 19 per cent fall in property loans.
Transactions in the property market have slumped to a 10-year low. Anthony Cheung, HSBC Securities chief economist, said that hopes for an improved economic performance in the second half of the year were based on revived activity across the border in mainland China.