Sentiment was further damaged by escalating concern over the banking sector in Europe and the United States, and the re-emergence of a bitter political row to raise Washington's debt ceiling.

Markets were also rocked by news that Chinese manufacturing had contracted for the third straight month in September, fanning fears over the plight of the global economy.

London's FTSE 100 index of leading shares tumbled 3.54 percent to 5,101.21 points, Frankfurt's DAX 30 recoiled 3.53 percent to 5,238.49 points and in Paris the CAC 40 shed 4.07 percent to 2,816.20.

Milan slid 3.01 percent and Madrid tumbled by 3.64 percent on persistent concern that Italy and Spain could fall victim to the fast-moving eurozone crisis.

In foreign exchange deals, the European single currency sank to $1.3506, and struck a new 10-year low against the yen as investors sought the safe-haven Japanese currency.

At about 0915 GMT, the euro dived to 103.14 yen, hitting the lowest level since June 2001.

The Federal Reserve announced overnight that it would shift $400 billion in its shorter-term debt portfolio holdings to longer-term bonds, a move it said would lower rates for mortgage holders and businesses.

The plan -- nicknamed Operation Twist -- would also entice banks to put some of their idle reserves to work. However, investors expressed severe doubts over whether the initiative would work.

"The negative mood has returned as doubts emerge regarding the effects of Operation Twist," said Spreadex trader Jordan Lambert.

"Investors are sceptical that forcing down long-term rates will spur activity in the stagnant housing sector as the problem seems to lie in prospective home buyers not being able to obtain the necessary borrowing.

"This is exacerbated by the banks' cautiousness to lend due to the dire unemployment situation."

Asian equities also plummeted Thursday as the Fed's latest multi-billion-dollar move to shore up the American economy was met with worldwide disappointment.

Hong Kong dived by 4.85 percent, ending below 18,000 points for the first time in more than two years on disappointment over the Fed's plan.

Tokyo plunged 2.07 percent, Seoul shed 2.90 percent and Sydney lost 2.63 percent to hit the lowest in more than two years.

Paris shares were dented by banks that are seen as exposed to risky sovereign debt in Italy and Greece. Athens on Wednesday unveiled more painful cuts to unlock bankruptcy-saving loans from the European Union and International Monetary Fund.

"The main themes dominating the markets today is the weakness of the US economy and the threat to the global banking sector after French, Italian and US banks hit the skids yesterday," said analyst Kathleen Brooks at trading site Forex.com.

"This is weighing on stock markets and has fuelled a flight from risk," she added, indicating that investors were dumping risky equities for safe-haven investments.

In announcing the new plan, the Fed warned of "significant downside risks to the economic outlook", with the economy struggling with slow growth, high unemployment and a depressed housing market.

Wall Street plummeted on the news, which followed the Fed's two-day monetary policy meeting. The Dow lost 2.49 percent, the S&P 500 dropped 2.94 percent and the Nasdaq shed 2.01 percent.

"While Operation Twist was well anticipated perhaps the severe warning from the Fed that 'there are significant downside risks to the economic outlook' was not," noted Rabobank analyst Jane Foley.

Investors also digested downgrades by Moody's on three top US banks -- Bank of America, Wells Fargo and Citigroup -- saying it saw the US government less willing than before to rescue them if they become unstable.

And markets were also rattled by news that the US House of Representatives had defeated a stopgap measure to keep the government open past October 1.

It was unclear how lawmakers will proceed as they seek a way to avert a standoff that could trigger a government shutdown in the wake of the damaging debt-limit fight that has already sparked a historic downgrade of Washington's debt rating.

Adding downward pressure to sentiment was preliminary data from China showing manufacturing contracted again in September, hurt by the ongoing troubles in key markets of the United States and Europe.

The early HSBC purchasing managers' index (PMI) fell to 49.4 last month from a final reading of 49.9 in August. A reading above 50 indicates the sector is expanding, while a reading below 50 suggests contraction.