Insurance stocks were among the biggest fallers as the FTSE 100 saw another sharp decline on the way to recording its worst two-day performance since the stock market crash of 1987.

Shares in Prudential slumped 19.5 per cent to 297¾p on fears the life assurer needed a rights issue. Its corporate bond portfolio caused worries.

Traders said the concerns had been stoked by a Goldman Sachs research note, which in most respects was positive. The broker highlighted several companies, including Pru and Aviva, down 10 per cent at 353p, that looked to be "tight" on capital after recent market falls and might need to take "prompt" action.

Old Mutual, the South African financial services group, lost 21.6 per cent to 49.6p. Traders said recent market turbulence could have caused more problems for the troubled company. In August, it was forced to inject £150m into its US life business to meet guarantees in policies after hedges failed to protect it against stock market falls.

The FTSE 100 dropped 218.2 points, or 5.4 per cent, to a five-and-a-half-year low of 3,861.4, taking losses over the past two sessions to 12.5 per cent and erasing all gains since Monday's bank bail-out announcement. The blue-chip index is 71 points, or 1.7 per cent, below last Friday's close of 3,932.1. The FTSE 250 lost 364.4 points, or 5.4 per cent, to end at 6,342.7.

Recession fears, with the release of some very weak US manufacturing and production data, and rumours that a couple of hedge funds had gone under, triggered yesterday's decline. Once again the mining sector was hit hard. Vedanta Resourcesshed 15.2 per cent to 632½p, while Anglo American fell 13.1 per cent to £11.53 and Xstrata dropped 13.6 per cent to 914p as Goldman Sachs became the latest broker to slash its metals price forecasts.

Cutting its 2009 iron ore and copper forecasts by 21 and 53 per cent, respectively, Goldman Sachs said: "Our bearish view of metals prices assumes weak metals demand in the western world cannot be offset by rapid growth in China." Rio Tinto dropped 13 per cent to £20.50 amid reports that Chinalco's 9 per cent holding in the company had been frozen by the administrators of defunct investment bank Lehman Brothers. However, after the market closed, Chinalco said it was in discussions with the administrators for the orderly transfer of the stake.

BP, down 4 per cent to 397½p, and Royal Dutch Shell, off 8.3 per cent at £12.35, were also under pressure as the oil price dipped below $70 a barrel for the first time since August 2007.

Tui Travel fell 22.1 per cent to 194.4p after majority shareholder Tui said it was no longer considering a bid.

BT fell 3.1 per cent to 132.7p as traders took the view the telecoms company is a highly geared play on the equity market because of its £37bn pension fund. BT's market value is just £10.3bn.

Barclays dropped 10.9 per cent to 213½p as investors banked profits made since Monday. Barclays started the week at 207½p and rose sharply after the bank said it did not need the government's help to raise £6bn via an issue of ordinary and preference shares.

Royal Bank of Scotland outperformed by holding steady at 65p, thanks to a rare positive broker note. Morgan Stanley said RBS looked cheap in the event of a break-up, something Stephen Hester, the bank's new chief executive, has said he is willing to consider.

"The value of RBS on a sum-of-the-parts basis is clear, in our view, and with the shares trading at 0.6 times tangible book we think a shift in direction toward realising this has got to be good for the share price and the resumption of dividends," the broker said.

Rexam, up 4.5 per cent to 309½p, bucked the weak trend after Credit Suisse pushed the stock to clients, highlighting its cheap valuation and dividend yield of 7.1 per cent.

Bodycote rallied 2.4 per cent to 130½p after broker Arbuthnot said the engineer was undervalued whether or not the £417m disposal of its testing business went ahead.

"The current share price seems to be discounting a 40 per cent, or more, decline in underlying profits, which is considerably worse than we or any other observer is expecting," said analyst Michael Blogg.