Dealers said this deadly combination known as 'stagflation' appears more likely over time as the global credit crunch plays out and the global economy slows markedly against the backdrop of soaring oil and other commodity prices.

They said the worry is that as inflation picks up, central banks will feel they have to hike interest rates to check prices even when slowing economies need lower borrowing costs to boost demand.

The European Central Bank has clearly warned that an interest rate hike is possible at its upcoming policy meeting in July while the US Federal Reserve, which began a two-day board meeting Tuesday, has recently taken a much harder line on inflation.

Stocks are beginning to come under sustained pressure because investors now feel that profits will falter as the global economy slows, dealers added.

In London, the London FTSE 100 index closed down 0.57 percent at 5634.70 points. In Paris, the Cac 40 lost 0.83 percent at 4473.76 points and in Frankfurt the Dax fell 0.81 percent to 6535.97 points.

The Euro Stoxx 50 index of leading eurozone companies fell 0.67 percent.

The euro was at 1.5589 dollars.

Oil prices meanwhile were close to 138 dollars, revisiting near-record highs.

In Asia, Japanese shares closed little changed but Hong Kong lost 1.14 percent while Sydney was marginally higher.

On Wall Street, opened lower were lower again as a negative outlook from parcels delivery giant UPS and news that home prices are still falling darkened the mood ahead of the Fed meeting.

However, sentiment steadied in a technical rally, with the Dow Jones Industrial Average up 0.19 percent at around 4.15pm GMT.

Dealers in New York said a profit-warning from UPS, seen as a bellwether for the economy, and news that the S&P Case Shiller home price index showed a year-on drop of 15.3 percent in major cities jolted sentiment at the start.

Adding to the negative tone, the Conference Board business research firm said its index of consumer confidence, which has slid all year, plunged to 50.4 points in June from 58.1 points in May.

"Worse-than-expected decline in sentiment"

In Europe, Peter Dixon, strategist at Commerzbank, said "markets are in a bearish (downwards) mode at the moment. We have had a pretty dreadful six weeks on the back of inflation fears, worries about central bank response and slowing growth."

In London, home builders and distributors led the losers, reflecting concerns that earnings in these key sectors will suffer as the economy slows but the banks got a boost from a bid for home loan specialist Bradford & Bingley.

Among the supermarket chains, Tesco lost 3.41 percent to 365.10 pence and Sainsbury was down 3.23 percent at 314.75 pence.

Bradford & Bingley jumped 17.05 percent to 77.25 pence after rejecting an approach from investment fund Resolution, thereby sparking speculation of counterbids to come.

In the other banks, HBOS climbed 1.67 percent to 274.75 pence, Barclays added 3.67 percent at 310.75 pence and Lloyds TSB was up 2.20 percent to 325.75 pence.

In Paris, construction stocks suffered with Bouygues down 2.43 percent to 40.87 euros and Vinci off 3.09 percent at 39.15 euros.

BNP Paribas bucked the market to gain 1.95 percent to 59.88 euros on positive broker comment.

In Frankfurt, the automakers were especially under pressure after the US consumer confidence survey because of the importance of the US market to their earnings.

Volkswagen lost 1.56 percent at 178.80 euros, BMW was down 3.40 percent to 31.25 euros and Daimler shed 3.84 percent to 41.86 euros.

Elsewhere in Europe, the Bel-20 in Brussels lost 0.95 percent, the Ibex-35 in Madrid lost 1.59 percent, Italy's Mib-30 was down 0.73 percent, the AEX 25 in Amsterdam was virtually unchanged as was the Swiss Market Index.

AFP