The top shares sank to their lowest close for a week on Wednesday on spiralling concerns over Italy's debt as the country's bond yields raced to dangerous levels.
Italy was thrown into the spotlight as its 10-year bond yields shot above 7 percent, levels that forced bailouts in Ireland, Portugal and Greece, and as investors dumped the debt after a clearing house increased margin calls.
The spike in yields came in spite of European Central Bank buying.
Silvio Berlusconi's pledge to step down as Italy's prime minister failed to calm markets.
I suppose a change in political leadership is important in terms of sentiment. The reform agenda I think is going to be positive, but probably not enough to calm market nerves, Henk Potts, market strategist at Barclays Wealth, said.
The European Financial Stability Facility is in place, but is probably not strong enough to insulate countries like Italy from contagion, and therefore it would appear that a wider European body, particularly the European Central Bank, would need to be the lender of last resort.
Financials <.FTNMX8350> came under severe pressure, with HSBC
HSBC's fall was also driven by a larger-than-expected drop in third-quarter profits for Europe's biggest bank.
When European leaders agreed their most recent bailout package, the deal imposed 50 percent losses on private sector Greek bondholders. Italy could be a different story.
I'm not sure that they (markets, banks) could afford to take a substantial haircut on the world's fourth biggest bond market, Darren Sinden, trader at Silverwind Securities, said.
The UK benchmark <.FTSE> closed down 106.96 points, or 1.9 percent, at 5,460.38, its lowest close since November 1, erasing the previous session's 1 percent gain, and having opened almost 1 percent higher.
Atif Latif, director of trading at Guardian Stockbrokers, notes aggressive buying of call spreads on five- and two-year German government bonds as a way of playing the market volatility.
Heading the list of fallers, car insurer Admiral
Shore Capital cut back its EPS forecasts for Admiral for 2011 and 2012 by up to 8 percent and reduced its dividend estimates for the same years by up to 7.3 percent.
Weakness was also seen from Resolution
Ex-dividend factors took 1.46 points off the FTSE 100 on Wednesday, with Barclays
On the domestic macroeconomic front, concerns over Britain's economy remain, with its goods trade deficit widening in September to its highest since the series began in 1998.
(Additional reporting by David Brett)