British blue chip stocks fell to their lowest close since late March on Thursday, driven by a steep decline in global financial shares as investors fretted about yet more losses at the banks.
A note from Goldman Sachs warning of more possible writedowns at US brokerages hit banking stocks early in the day and the sector was the worst performer on the FTSE 100, as HSBC, Standard Chartered, Royal Bank of Scotland and Lloyds TSB all fell between 3.3 and 7 percent.
The FTSE 100 closed down 147.9 points, or 2.6 percent, at 5,518.2 points, making this its lowest close since March 20 this year, and its biggest one-day fall in over a month.
The FTSE has fallen by about 14 percent so far this year, ranking among the better performing indexes in Western Europe, thanks in large part to the out performance of its heavyweight mining and energy sectors.
"The story is the banks and the view is, and has been for a while, that the banks have lost a lot of their capacity to finance economic growth. They're having trouble financing their own activities, let alone those of others," said Mike Lenhoff, chief strategist at Brewin Dolphin.
"It's all part and parcel of what has been driving this market, the credit crunch is manifesting itself in what we're now seeing with the banks so that's the story, it's helping push the market down."
The US Federal Reserve's widely expected decision on Wednesday to leave rates unchanged was no surprise. But the bank's reiteration of its concern about inflation in its post-decision statement ruffled investors. Bank of England policymakers testifying before parliament's Treasury Select Committee on Thursday also noted increased inflation expectations, a factor driving investor expectations of a rate rise in the UK, traders said. "It's the extension of the trend we've been seeing for some time," said Jim Wood-Smith, head of research at Williams De Broe.
"The Treasury Select Committee is saying inflation is going to be even higher, growth will be even slower and there's going to be more contraction in banks' balance sheets which means that there's no end in sight for the credit crunch."
Companies selling to the banking sector also suffered with global information provider Thomson Reuters falling 5.8 percent after Morgan Stanley cut its price target on the stock. Mining stocks were the second-worst performers, with BHP Billiton dropping 2.3 percent, Xstrata and Rio Tinto both down 2.7 percent.
Energy shares reversed an earlier rise even as crude oil rose 2.5 percent. BP was down 0.7 percent and Royal Dutch Shell was up 0.1 percent, having risen earlier by 1.7 percent.
Shares in the London Stock Exchange fell 7.1 percent, having gained 14 percent on Wednesday after Qatar's sovereign wealth fund was quoted on television saying it was in talks with London and German stock exchanges for a new partnership.
The LSE and Lehman Brothers said on Thursday that they planned to set up a pan-European off-bourse trading platform. Traders said there had already been speculation about the deal.
Tesco was also among the largest individual drains on the FTSE, falling by more than 4 percent after reports that US Democratic presidential candidate Barack Obama has stepped up his appeals to the supermarket to let unions represent workers at its new US chain.