New speculation that France could be downgraded by ratings agencies triggered a massive sell-off of shares across Europe on Wednesday, wiping out gains recorded in Tuesday's session and cutting short hopes that markets will make a quick recovery before the global debt crisis escalates.
European shares rebounded in early trade on Wednesday and recouped much of the losses registered in the days since Standard & Poor's downgraded the US credit rating.
However, their recovery was short-lived as stock markets became jittery over reports that France could be the next in line to be downgraded after the United States, which for the first time lost its top-level AAA credit rating last week.
Banking shares led the free fall and dragged almost all major European indexes down with them.
Renewed fears that the twin debt crisis in Europe and in the United States could spark off a worldwide economic slowdown, as happened in the aftermath of the collapse of US investment bank Lehman Brothers in 2008, also weighed heavily on the markets.
Gold prices climbed to a new record level of $ 1,779.14 per ounce as investors flocked to their traditional safe haven, while the euro lost ground and dropped by two cents to $ 1.4175.
In Frankfurt, Germany's benchmark DAX index began Wednesday's session positively and rose by 3 % to reach 6,089 points, boosted by the US Federal Reserve Board's announcement on Tuesday that it would keep interest rates unchanged at near zero % for the next two years.
The European Central Bank's intervention this week to buy government bonds of Italy, Spain and other financially troubled eurozone nations also helped to push the DAX and other major European indexes into positive terrain in early trade.
However, the gains were wiped out after rumours began spreading in the afternoon that France could soon join the United States, Belgium and New Zealand, a group of industrialised nations that have lost their top-notch AAA credit rating.
The DAX lost 5.13 % to close in Frankfurt at 5,613.42 points, compared to Tuesday's finish of 5,917 points, down by 0.1 %.
The FTSE-100 index in London closed 3.1 % lower at 5,007.16, while the Ibex-35 in Madrid dropped by 5.49 % to 7,966 points.
Italy's FTSE MIB index in Milan ended 6.7 % down, very close to the lowest level reached during the height of the financial crisis in 2008.