European stock prices fell to their lowest levels since the 1997 Asian financial crisis yesterday. And with fears of global recession and war undermining sentiment, dealers see little respite for markets, some of which have lost 40 per cent of their value since the beginning of the year.

Fears over the extent of retaliation for the attacks which left more than 5,000 people dead or missing kept the mood sombre, after the Pentagon gave orders to move about 100 warplanes towards the Middle East and Indian Ocean.

Meanwhile, the European Central Bank hinted at more rate cuts to come. In its monthly bulletin it warned that the attacks "are also likely to weigh on confidence in the euro area and on the short-term outlook for economic growth" in the single-currency zone. Fallout from the terrorist attacks threatened "to push the (euro-zone) economy into a more marked and protracted slowdown".

The ECB predicted that euro-zone inflation was set to fall back below the key level of 2 per cent "in the not-too-distant future", comments which some observers interpreted as a signal that the bank was pointing at rate cuts to come.

According to Mr Jim Power, investment director at Friends First, the ECB is likely to lower rates by another percentage point bringing them to 2.75 per cent before Christmas.

Some of the heaviest losses were suffered on continental European markets and in Frankfurt, the Xetra Dax index fell almost 5 per cent, bringing the fall in the Dax since the start of the year to more than 40 per cent. This means that Germany's index of blue-chip shares has fallen as much as the technology-heavy Nasdaq market - a damning indication of how the market views German economic prospects.

In London, the FTSE-100 index fell 3.5 per cent to its lowest level since June 1997 with banks, airlines and insurance stocks suffering the brunt of the selling. On the Irish market, almost €2.7 billion (£2.13 billion) was wiped off the value of Irish shares with heavy selling across the board. The pan-European FTSE Eurotop 300 index was off 3.9 per cent and the DJ Euro Stoxx 50 down 4 per cent.

All of Europe's sector indices lost ground, with insurers and autos the biggest decliners, down more than 6 per cent apiece.

"The market is still blinded by uncertainty over the extent of American retaliation in the Middle East and how on earth they are going to do it," said Natwest Stockbrokers head of research Mr Jeremy Batstone.