Sterling and the FTSE 100 Index slid after figures revealed a shock contraction in the UK economy in the final three months of 2010.
While much of the 0.5% decline in GDP was blamed on weather factors, economists said the report from the Office for National Statistics heightened fears over the ability of the UK to withstand austerity measures.
The FTSE 100 Index had been trading in a narrow range prior to the figures but slumped more than 40 points following the blow to confidence. It later recovered to stand 19 points lower at 5924.6.
Sterling was down more than 1% against the US dollar as traders thought the chances of a rise in UK interest rates had declined.
Michael Hewson, a market analyst at CMC Markets, said: “There are now concerns that the UK economy could get mired in stagflation at a time when none of the major cuts has even started to bite yet.”
Unsurprisingly, consumer-facing stocks were among those unnerved by the weaker growth prospects as Next dropped 59p to 2083p, Marks & Spencer fell 6p to 363.4p and Tesco declined 5.45p to 400.05p. In the banking sector, Lloyds Banking Group eased 1.7p to 63.4p, Royal Bank of Scotland dropped 0.7p to 1886p and Barclays weakened 3.7p to 296.8p.
The market was also hampered by weaker commodity stocks as investors continued to worry about possible moves by China to curb soaring economic growth. Randgold Resources was among the fallers, dropping 131p to 4904p, while Kazakhmys fell 36p to 1522p.
One of the most significant moves in the top flight came from BSkyB after the Culture Secretary kept the door ajar for News Corporation’s planned takeover of the broadcasting giant.
Jeremy Hunt said he was minded to recommend a full investigation by the Competition Commission but before doing so will consider undertakings made by News Corp in order to address media plurality concerns. With the company also due to post strong half-year results on Thursday, BSkyB shares lifted 6p to 756p.
In the FTSE 250 Index, shares in Imperial Leather soap maker PZ Cussons fell 8% after it reported flat half-year profits and said it was cautious about prospects for the full year due to discounting by UK retailers. The company, which dropped 30.8p to 348.4p, is also battling soaring input costs such as palm oil, a key ingredient in many of its products.