Stock markets slumped and the euro hit a fresh 11-month low against the dollar amid renewed fears that Europe will be forced to rescue Italy and Spain from a lending boycott by international investors.

The FTSE index of Britain's top 100 companies dropped 2.25% to lead falls on continental exchanges and the US markets in a day of volatile trading. France's CAC 40 was the worst performer among major European indexes, falling 3.3%, followed by Italy's FTSE MIB, which dropped 2.8%.

Investors singled out Italy for more pain as they sent the interest rate on the all-important 10-year bond past 7% to hit 7.17%. The euro fell to $1.30, the lowest since January.

French lenders Société Générale, BNP Paribas and Credit Agricole fell between 6.7% and 8% as rumours persisted that the extent of their bad loans to indebted eurozone countries would lead to France losing its AAA status within the next few days. Credit Agricole, which gave a second profits warning this year, said it would record a €2.5bn (£2.09bn) loss this year, chiefly due to writedowns in its investment banking unit, and it would not pay a dividend in order to retain capital.

Analysts warned that Italy would be forced to turn to Brussels for bailout funds unless member states agreed a more coherent rescue package with more firepower to protect the currency union. An agreement last week to move towards greater harmonisation of fiscal rules initially pleased markets but in recent days investors have viewed the deal as weak and subject to wrangling and delay.

A sense of confusion inside the eurozone was exacerbated after Angela Merkel, the German chancellor, renewed her opposition to expanding the bailout fund for the euro, insisting that €500bn was the limit. Merkel, speaking to the German parliament for the first time since the a package of measures was agreed in Brussels last week without the support of Britain, said the fund was capable of providing a firewall to protect indebted countries such as Italy, despite widespread concerns that the fund needs access to at least €2tn to reassure investors.

Another key element of the deal, an agreement to boost the International Monetary Fund through €200bn in bilateral loans from EU central banks, has also run into trouble.

Jens Weidmann, Germany's central bank chief, threatened to boycott the move unless non-eurozone IMF contributors, such as the US and Britain, also provided additional loans. In a letter to the German finance minister, he insisted that the German contribution of €43bn has to be endorsed by the German parliament.

Analysts Tobias Blattner and Emily Nicol of Daiwa Capital Markets said: "With the US, UK, Canada and Japan already having ruled out an increase in their lending to the IMF, comments by Weidmann appear to kill off the €200bn of additional IMF resources promised last week."

They added that the dire situation with the euro and the flight of savings to safe havens means "a downgrade by Standard & Poor's of most of the euro area's sovereign and bank credit ratings looks increasingly likely".

The regional government in Catalonia and Italy's largest bank added to the confusion after they appeared to undermine the thrust of policies agreed in Brussels.

The Catalonian government, one of 17 semi-autonomous regions in Spain, launched a legal case to force the central Madrid administration of Mariano Rajoy to send €759m in unpaid tax monies back to Barcelona. In the first case of its kind, the Catalan government will take the recently elected central government to court to recover the funds. The Spanish treasury has withheld the funds as part of its austerity effort. Officials have accused regions of overspending their budgets and jeopardising an austerity programme designed to meet targets set in Brussels.

Federico Ghizzoni, the chief executive of Italian bank Unicredit, said calls for banks to use cheap loans from the European Central Bank to buy Italian debt were misguided. He said Unicredit, the largest bank by value in Italy, would not use the extra liquidity aimed at lowering their borrowing costs to buy government bonds.

The comments contradict a statement by Nicolas Sarkozy, the French president, who said at the EU summit that the ECB's increased liquidity provisions for lenders meant countries such as Italy and Spain could look to their banks to buy their sovereign debt.

• This article was amended on 15 December 2011. The original said the euro fell to €1.30 against the dollar. This has been corrected.