Shares fell sharply across Europe today and the euro hit a new four-year low after Germany's financial regulator announced new curbs on financial speculators last night.

Tension in the financial markets ratcheted up this morning after the German chancellor, Angela Merkel, warned that the single European currency was in danger of collapse, and that Europe faced its greatest crisis in decades.

"Every one of us here can feel that the current crisis of the euro is the greatest challenge that Europe has faced for decades, since the signing of the Treaty of Rome," Merkel said in a speech to the Bundestag.

"The euro is in danger ... If we don't deal with this danger, then the consequences for us in Europe are incalculable."

Traders were already alarmed by last night's immediate and unexpected ban on "naked short-selling" – the practice of selling shares without owning them, borrowing them, or ensuring that they can be borrowed in the future. The clampdown covers sovereign bonds issued by eurozone countries, credit default swaps (CDS) on those bonds, and the shares of 10 of Germany's biggest financial institutions including Deutsche Bank and Commerzbank.

The ban will run until 31 March 2011. Although it will only cover trading covered by Bafin (the German regulator), some experts believe Germany hopes to push through Europe-wide restrictions.

The FTSE 100 fell by as much as 2.5%, or 131 points, in morning trading to 5175 with every single member of the index of leading shares falling in value. France's CAC 40 dropped 2.8% and Germany's DAX lost 2.2%, while Spain's Ibex index shed 3.3%. There was little reaction on Wall Street, though, where the Dow Jones index rose four points to 10,515 when trading began.

Ben Potter, research analyst at IG Markets, said: "German restrictions on short-selling seem set to send another shockwave across markets as investors are once again left asking questions over the resilience of Europe."

US regulators had outlawed naked short-selling in 2008 as the financial crisis escalated. Germany's unilateral move had raised fears of another bout of turbulence, with some analysts speculating that Germany's banks are more threatened by the Greek debt crisis than first thought.

Germany's finance minister, Wolfgang Schäuble, said this new ban, which came into effect at midnight last night, would thwart the speculators – or "wolf pack" – who European leaders blame for attacking the euro and their sovereign debt.

But City experts were broadly united in attacking the proposal as badly thought out, and potentially counter-productive.

Atsushi Mizuno, a former board member of the Bank of Japan, agreed that the move could backfire. If investors cannot hedge their exposure to Europe by naked short-selling of bonds and CDS contracts, then they may simply concentrate on selling the euro instead.

"Downward pressure on the euro will likely heighten," Mizuno told a seminar in Toyko on Wednesday.

Shortly before Mizuno spoke, the euro fell to $1.2146 against the dollar, the lowest since April 2006. It also hit a record low against the Swiss franc.

In her speech to the German parliament, Merkel called for tighter supervision of financial markets, and a new levy on the banking sector. He also said that the eurozone needed a mechanism to organise the orderly insolvency of member states.

Wolf pack woes

Gary Jenkins of Evolution Securities argued that it was pointless for European leaders to simply blame avaricious financial markets for their woes.

"The key for eurozone governments at this time is to demonstrate to the market that they are worthy borrowers in order to be able to access liquidity. Thus the derivative market is to some degree a sideshow because the way that the governments raise cash is via the old-fashioned, plain-vanilla government bond market," said Jenkins.

"The problem has not been one of 'evil speculators' or 'wolf packs' (and anyhow, what self-respecting fairy-tale wolf doesn't attack pigs?) but of investors' concerns that government finances are so out of control, and that the amount of money they need to raise is so large that there is a prospect of much higher yields, at best, or the inability to repay at worst," he added.

Uwe Parpart, chief Asia strategist at Cantor Fitzgerald, was also unimpressed.

"Pathetic! Unable to muster the political will or intelligence to tackle fiscal restructuring, EU regulates hedge funds and Germany bans naked shorts," Parpart wrote in a research note.

It is also unclear how well this ban can be implemented, given that most CDS contracts are traded in the US or UK. But despite the negative reaction, analysts also believe other European countries could follow Germany's move.

"The action taken may be seen as underscoring the seriousness of the situation that governments face, or as a political manoeuvre designed to win support for the €750bn [£640bn] bailout package. Either way, we would expect other countries to adopt these proposals," Jenkins predicted.

Belgium's financial watchdog confirmed this morning that it is considering bringing in similar curbs. In London, the Financial Services Authority said it would assist German regulators, but added that the ban did not cover trading outside Germany.