The FTSE 100 closed down 1.7 per cent at 5,598.23 after a plunge in mid-afternoon caused by EU energy minister Gunther Oettinger telling the EU parliament that Japan's damaged nuclear plant was "out of control" and a catastrophe with loss of life was imminent.
“Both the Dow Jones and FTSE 100 sold off sharply in a matter of minutes of these words being spoken with the Dow Jones losing over 100 points within five minutes of trading,” said City Index market strategist Joshua Raymond.
Shares in London, Paris, Frankfurt and New York all fell sharply, while oil prices rose. Germany's DAX ended down 1.8 per cent and France's CAC-40 was two per cent lower.
It eventually transpired the comments were not based on new or privileged information, but the market struggled to recover.
Investors were "jittery and ready to take cover at the slightest provocation,” said IG Index chief market strategist David Jones.
Rating agency Moody’s downgraded Portugal’s sovereign debt by two notches to A3 and said it might have to downgrade again given the impact of high borrowing costs and the difficulty of meeting tough fiscal targets.
“Moody’s decision to downgrade Portugal reminded investors that despite the nuclear problems emanating from Japan, Europe has a toxic problem of its own in the form of a beleaguered banking sector,” said CMC Markets analyst Michael Hewson.
Banks and heavyweight commodity issues dragged the FTSE down, led by insurer Standard Life (down 5.3 per cent at 199.5p) and followed by HSBC (down 3.6 per cent at 622.5p) as they both went ex-dividend.
Barclays also fell 3.4 per cent to close at 282p on sovereign debt concerns.
Among few risers were 3i Group, which gained 2.2 per cent after its chief executive Michael Queen stepped in and bought 100,000 shares for more than £280,000.
Associated British Foods also added one per cent after broker Credit Suisse upgraded it to “outperform”.
In the US, new economic data showing input price inflation and a large fall in new homes being built added to the market’s woes.
Apple closed 4.5 per cent down at 330 cents as it received a rare downgrade from JMP Securities, which queried the impact of Asian weaknesses on its performance.
The Dow Jones industrial average was down 242.12 points, or two per cent, at 11,613.30; the S&P 500 index was down 24.99 points, or two per cent, at 1,256.88.
The Nasdaq Composite index was down 50.51 points, or 1.9 per cent, at 2,616.82.