The FTSE 100 plunged by 2.2% on Tuesday morning following news that Greece plans to hold a referendum on a proposed eurozone bailout.
European markets also reacted badly to the surprise move. By mid-morning Germany's Dax had fallen by -4.38% , the Cac-40 in Paris by 4% and the stock market in Athens plunged by 7%. In the United States the Dow Jones was down by -2.26%.
The decision by Greek Prime Minister George Papandreou to hold a referendum is reported to have shocked eurozone leaders, who last week agreed to cut Greece's debts by 50% and hand over £112bn more in rescue loans.
Papandreou said: "We have faith in our citizens, we believe in their judgment and therefore in their decision".
"All the country's political forces should support the [bail-out] agreement. The citizens will do the same once they are fully informed."
The precise date of the poll is yet to be announced, but it is expected to be held in January. There have been widespread and violent protests in Greece over the austerity measures imposed on the country by its government.
Markets tumbled ahead of figures released by the Office for National Statistics showing the British economy grew by 0.5% in the third quarter of 2011 - slightly more than expected.
The moderate growth was an increase from the second quarter - in which the economy grew by 0.1%.
On Monday think tank IPPR warned a recession could last six years in the country with the economic recovery is the "slowest ever in UK history".
Writing in the New Statesman, IPPR chief economist, Tony Dolphin said the recession could be longer than the one experienced in 1979.
“This is shaping up to be the longest recession the UK has ever experienced. If we take the Office for Budget Responsibility's (OBR's) latest forecasts for 2011Q4 onwards, real GDP will not exceed its previous peak until the second quarter of 2013 - fully five years after the recession began," he said.
"This will make it a year longer than the previous longest recession - the one that began in 1979."
While on Monday the the International Labour Organisation (ILO) said the global economy was on the verge of another deep recession recession that will hit any global economic recovery.
George Osborne is due to face MPs in the House of Commons this afternoon where he is likely to be grilled on the growth figures and the Greek referendum.
On Monday David Cameron said the coalition would not deviate from its deficit reduction plan, despite slowing growth and growing unemployment.
Writing in the Financial Times the prime minister said Instead, the government will focus on infrastructure investment and “credit easing” in order to restart the economy.
The age of austerity has also hit the festive spirit, with research showing people intend to spend less on Christmas presents this year than in the past.