The Nikkei's decline came despite good economic news in Japan
World stock markets have fallen despite Japan becoming the latest country to officially come out of recession.
Analysts say that investors are worried that they may have been too quick to predict an economic rebound during recent rallies.
Leading Wall Street markets fell about 2% lower after similar losses in the UK, mainland Europe and bigger drops in Asian markets.
Meanwhile sterling has fallen back against the euro and the dollar.
Having touched 1.19 euros earlier this summer, the pound dipped below 1.16 euros, while also dropping 1.5% to $1.635.
The pound has suffered as the UK's economy appears to be lagging behind others. The latest weakening began after the Bank of England decided to pump more cash into the economy with the extension of its quantitative easing programme, just before France and Germany came out of recession.
The FTSE 100 index closed down 69 points, 1.5% at 4,645. while Germany's Dax fell 107.5 points, 2% to 5,201.6. The Cac-40 in France lost 2.2%, 75.6 points to 3,419.7.
Overall, however, the FTSE has grown by roughly 300 points in the last four weeks and the Cac by nearly 400.
US markets also fell sharply - the Dow Jones index losing 2% or 186.1 points, to 9,135.3 while the tech-heavy Nasdaq shed 2.75%, 54.68 points to 1,930.8.
"There is now a realisation that coming out of a recession is one thing, but building a recovery is another," said Justin Urquhart Stewart, director at Seven Investment Management.
"The growth we have seen out of Japan as well as Europe looks like it has been primarily based on government stimulation... The question is, is it sustainable?"
Earlier, China's main Shanghai index fell 5.8% to 2,870.63, while Japan's Nikkei 225 fell 328.72 points (3.1%) to 10,268.61. Hong Kong's Hang Seng and South Korea's Kospi also fell .
However, the Nikkei is still up by almost 900 points since mid-July.
The price of US light, sweet crude fell below $66 a barrel - its lowest level this month - on concerns demand may remain subdued due to the US economy showing no sign of rapid recovery.