Fears that Italy will be forced to seek a bailout sent Italian government bonds falling on Monday, as Europe's most senior finance ministers gathered to discuss the ongoing eurozone debt crisis.
The FTSE Mib sank to a 14 month low.
In Italy shares were down almost 4%, in France the Cac index fell 2.7%, Germany's Dax fell 2.3%, and London's FTSE 100 was down 1%. Banks across Europe were hit hard, with Italy's Unicredit down 6.3%.
Eurozone finance ministers were holding talks on a new aid plan for Greece, but this was overshadowed by fears of contagion spreading to Italy and Spain.
The market plunge came as ministers tried to assure markets that Italy would not need a bail-out.
“Italy can get out of this situation on its own and with the help of all European countries but not with financial aid,” Spanish Economy Minister Elena Salgado insisted before a meeting of euro-area finance ministers in Brussels.
The concern was shared in Europe's stock markets, with the FTSE 100 falling 65 points by lunchtime.
The yield, or interest rate, on an Italian 10-year government bond jumped to 5.4%, closer to the 7% level which is generally seen as unsustainable.
"What will really concentrate the mind of the finance ministers will be the recent upward trend in Italian government bond yields," said Gary Jenkins, head of fixed income research at Evolution Securities. "What would keep me awake at night if I was a European finance minister is that we are only about 2% away from a potential disaster scenario."
Britain's FTSE 100 also sank 1.2pc to 5,918.31, while Frankfurt's DAX 30 lost nearly 2pc to 7,352.73, and in Paris the CAC 40 fell 2.15pc percent to 3,878.60.
In New York, the Dow Jones Industrial Average fell 1pc to 12,530 in opening deals.