World stock markets accelerated their falls on Tuesday as Italy struggled to avoid being sucked into the escalating European debt crisis, and Greece moved closer to a default.

Bank shares were in retreat across Europe, driven by fears that Italy will soon be unable to borrow on the international money markets. The euro continued to lose value rapidly and hit a low of $1.388 – it has now lost more than 3 cents against the dollar since Monday morning.

The FTSE 100 index slumped by 133 points at one point in London, down more than 2.25%. It recovered some losses during a volatile trading session, and by 2.45pm it was 52 points lower at 5876. Barclays fell as much as 6.5% to 218p followed by Lloyds, down 4.7% at 42p.

"The banks are biggest fallers, because of concerns that the European crisis is spreading to Italy and Spain," said David Jones, chief market strategist at IG Index.

Losses were also heavy across Europe. The German DAX was down as much as 2.1%, with France's CAC 2.3% lower.

In the bond markets, the yield – or interest rate – on Italian 10-year bonds approached 6%, the highest in at least a decade. Spanish yields hit 6.2%. Economists have warned that these borrowing costs are approaching unsustainable levels.

Italy succeeded in selling €6.75bn (£6bn) of 12-month Italian bonds on Tuesday morning, but at an average yield of 3.67% – the highest interest rate on such debt since September 2008, following the collapse of Lehman Brothers.

This helped the main Italian index, the FTSE MIB, to recover some losses. It tumbled by 4.1% in early trading – with shares in Italy's biggest bank, Unicredit, being temporarily suspended after falling more than 7%.

On Monday, finance minister Giulio Tremonti pledged an unprecedented package of austerity measures to reassure the markets.

The slump in the euro illustrates the pressure that is building up against the single currency as Europe's debt crisis rumbles on, warned Jane Foley, senior currency strategist at Rabobank International.

"The contagion that is eating its way through the Spanish and Italian and other European bond markets has a self-prophesying element to it. The greater its foothold the more difficult it will be for affected countries to keep their debt maintenance costs and budgets in line," Foley said.

"Too much more delay and EMU [Economic and Monetary Union] could implode," she added.

Torrid time ahead

European finance ministers admitted on Monday night that Greece is likely to default on some of its debts. However, the EU still lacks the firepower to offer meaningful financial help to either Italy or Spain, if needed.

Gary Jenkins, head of fixed income research at Evolution Securities, warned that the lack of resolution to the wider European debt crisis is testing investors' patience.

"If the endgame is to be the issuance of common European bonds and some sort of fiscal union then one wonders why they just don't get on with it rather than risk totally losing control of the situation," Jenkins said in a research note.

Stock markets in Asia also suffered heavy losses overnight, with Japan's Nikkei losing 1.43% and the Hong Kong Hang Seng index dropping by 2.57%.

"Yesterday's heavy bout of selling in Europe and the US amidst escalating fears over the health of the Italian economy unsurprisingly has taken its toll … There's the potential for another torrid day ahead," warned Cameron Peacock, market analyst at IG Markets.

The cost of insuring government debt issued by Greece, Spain, Portugal, Italy and Ireland all rose on Tuesday, according to data from Markit. Gavan Nolan, director of credit research at Markit, warned that "the pressure is mounting on Europe's decision makers".