Berlin: New speculation that France could be downgraded by ratings agencies triggered a massive sell-off of shares across Europe on Wednesday, wiping out gains recorded in Tuesday's session and cutting short hopes that markets will make a quick recovery before the global debt crisis escalates.

European shares rebounded in early trade on Wednesday and recouped much of the losses registered in the days since Standard & Poor's downgraded the US credit rating.

However, their recovery was short-lived as stock markets became jittery over reports that France could be the next in line to be downgraded after the United States, which for the first time lost its top-level AAA credit rating last week.

Banking shares led the free fall and dragged almost all major European indexes down with them.

Renewed fears that the twin debt crisis in Europe and in the United States could spark off a worldwide economic slowdown, as happened in the aftermath of the collapse of US investment bank Lehman Brothers in 2008, also weighed heavily on the markets.

Gold prices climbed to a new record level of USD 1,779.14 per ounce as investors flocked to their traditional safe haven, while the euro lost ground and dropped by two cents to USD 1.4175.

In Frankfurt, Germany's benchmark DAX index began Wednesday's session positively and rose by 3 percent to reach 6,089 points, boosted by the US Federal Reserve Board's announcement on Tuesday that it would keep interest rates unchanged at near zero percent for the next two years.

The European Central Bank's intervention this week to buy government bonds of Italy, Spain and other financially troubled eurozone nations also helped to push the DAX and other major European indexes into positive terrain in early trade.

However, the gains were wiped out after rumours began spreading that France could soon join the United States, Belgium and New Zealand, a group of industrialised nations that have lost their top-notch AAA credit rating.

The DAX lost 5.13 percent to close in Frankfurt at 5,613.42 points, compared to Tuesday's finish of 5,917 points, down by 0.1 percent.

The FTSE-100 index in London closed 3.1 percent lower at 5,007.16, while the Ibex-35 in Madrid dropped by 5.49 percent to 7,966 points.

Italy's FTSE MIB index in Milan ended 6.7 percent down, very close to the lowest level reached during the height of the financial crisis in 2008.  

In Paris, the French government strongly denied that a downgrade of the country's credit rating was imminent and dismissed those reports as "pure speculations", media reports said, quoting a Finance Ministry spokesman.

However, President Nicolas Sarkozy cut short his holiday in southern France and rushed back to Paris to chair an emergency meeting of his key Cabinet colleagues.

He announced after the meeting that the government is determined to reduce the deficit in its budget for 2012 and it will unveil a package of austerity measures on August 24 to achieve this goal, the reports said.

The Paris stock exchange also saw massive sell-off after a positive start and the CAC40 index lost a large part of the gains recorded earlier on Wednesday and closed 5.5 per cent lower at 3,331 points.

European banking shares, led by French and Italian titles, were among the worst hit in Wednesday's plunge.

Investors were concerned about the massive debt write-offs French banks have to make as part of a eurozone deal on July 21 to provide a second multi-billion euro financial bailout for debt-ridden Greece.

Shares of Germany’s Deutsche Bank and Commerzbank were also caught in the downward spiral, even though their exposure to Greek debt was much smaller than French banks.