The FTSE-100 index closed 1.3% lower after an 84.93 point fall to 6270.44, while Italy's MIB plunged nearly 5% and markets in France and Germany fell by more than 2% as the deadlock is expected to make it harder for Italy to pass the reforms it needs to reduce its debts.
Wall Street shrugged off the eurozone worries as the Dow Jones Industrial Average rose more than 50 points in early trade after US new-home sales saw the biggest jump in nearly two decades last month and as US Federal Reserve chairman Ben Bernanke reinforced his commitment to the Fed's bond-buying programme.
This failed to ease declines on the London market as investor sentiment was also hit by weak manufacturing figures from China and the prospect of spending cuts in America ahead of a deal to trim the budget deficit.
Yesterday's sharp decline for the FTSE comes after the top flight approached a fresh five-year high on Monday, despite the fall-out from the decision of ratings agency Moody's to strip the UK of its AAA status.
The pound, which received a battering after the ratings blow, fell further despite euro weakness after Bank of England deputy governor Paul Tucker said he was open to more monetary easing and that the pound may need to fall further.
Sterling fell to $1.51 and just under €1.16 as he also revealed to MPs that policymakers had discussed the possibility of negative interest rates.
Banks were hardest hit in the market sell-off, with Barclays down 14.7p at 297p, Royal Bank of Scotland off 15.3p at 339.5p and Lloyds Banking Group 1.8p lower at 53.1p.
They were joined by leisure group Whitbread after it reported slower sales growth in the 11 weeks to February 14. The figure of 2.7% compared with 3.3% in the previous quarter but the Premier Inn, Costa and Beefeater owner said some of the slowdown reflected the wintry conditions last month.
Shares in the top flight stock fell 94p to 2469p.
In the FTSE 250 Index, shares in Sports Direct International were 5% lower after it emerged that Mike Ashley has sold a 4% stake worth £100 million.
The discounted price of £4 raised eyebrows, while there are fears Mr Ashley was calling the top of the share price after a rally that has seen the stock jump 46% over the past year.
The disposal of 25 million shares will still leave Mr Ashley with a 64% stake. Sports Direct shares were 21.5p lower at 409p.