In the US, the Dow Jones was down by 2.24%, the broader S&P 500 index 2.296% lower, and Nasdaq 2.74% lower.

In Europe, the FTSE 100 in London was down by 2.89%, Germany's Dax index was 2.97% lower, while in France the Cac 40 index had dropped 3.81%.

The FTSE fell as low as 4,939.6 points at one point, its lowest level for eight months.

Asian markets also saw sharp falls. Stocks in South Korea and Japan had been affected as North Korea reportedly went on to military alert.

North Korea later announced it was severing ties with South Korea.

In London, the FTSE 100 has fallen by more than 10% in little more than a month after hitting a 22-month high in April.

'Toxic cocktail'

The concerns about eurozone debt follow Monday's strongly-worded comments from the International Monetary Fund that the Spanish economy needs comprehensive and far-reaching reform.

That added to investors' worries over the weekend rescue of Spanish bank Cajasur by the Bank of Spain, only the second time the central bank has saved a regional lender.

Amid concerns over solvency in the sector, and in the wake of the Cajasur rescue, four Spanish savings banks then announced plans to merge.

Cajastur, Caja de Ahorros del Mediterraneo, Caja Extremadura and Caja Cantabria said they had reached agreement to form a group that would "strengthen solvency and assets of the participating banks".

"There's never been any mystery about the excessive exposure of Spain's banks to a bloated property market," said BBC business editor Robert Peston.

"The mystery has been how its banks avoided crippling losses on this exposure - although that increasingly looks like pain postponed rather than avoided.

"Or, at least, that's what today's retreat in share prices across Europe is saying, with bank shares falling especially sharply," he added. 

Richard Hunter, head of equities at Hargreaves Lansdown stockbrokers, said: "The toxic cocktail worsens. Continuing fears over the European debt situation stalling the global economic recovery has been exacerbated by the potential of military tensions in Korea."

And he said there was a shortage of buyers prepared to commit to the market at the present time.

The continued weakness of the euro is a concern, with investors dumping the currency amid fears that debts will cause defaults by weaker countries in the European Union.

In Tuesday trading the euro was down against the dollar and pound again

Sterling was up 0.7% to 1.17 euros, and the euro fell by around 1% to $1.22.

"The euro problems are very deep-rooted as eurozone members share a common currency but fiscal policies are left to each country," Japanese Finance Minister Naoto Kan told reporters.

"I hope financial markets will calm down gradually."

'Sluggish recovery'

On Tuesday, the European Union Economy Commissioner, Olli Rehn, warned that governments needed to make major reforms to boost growth.

"The big risk is that once the recovery gets more robust, we sit idly in self-complacency and forget the structural reforms.

"That would lead us to a sluggish recovery - or even a lost decade," he said in a speech at the Brussels Economic Forum.

He said the reforms needed for each European country varied, but he called for the opening up of national markets.

Countries such as Greece, at the centre of fears about the eurozone economy, have regularly ignored EU calls to liberalise markets.

Another nation which has ignored calls to open its markets is Italy, which is set to reveal an austerity budget later on Tuesday.

Regional tensions

Earlier in Asia, Japanese stocks fell by 3.1%, and shares in South Korea fell by 2.7%.

Australian shares fell by 3%, Taiwanese stocks dropped 3.23% and the wider MSCI measure of Asia-Pacific shares outside of Japan fell by 3.6%.

Shares in Hong Kong, Singapore, Indonesia, China, India, Thailand and Malaysia all fell.

There were reports in South Korea that North Korea had told its military to prepare for war, but only if the South attacked it first.

Tensions in the region have been growing since international investigators blamed the North for torpedoing and sinking a South Korean warship in March, killing 46 sailors.

The falls in Asia come after major markets in the US closed lower overnight, with the Dow Jones shedding 1.2% and the S&P 500 dropping 1.3%. 

Source : http://news.bbc.co.uk/2/hi/business/10151772.stm