European and U.S. stock markets fell sharply Tuesday after worse than expected German industrial production data and a warning from a leading credit ratings agency that the U.S. government needs to get its public finances in shape soon.

In Europe, the FTSE 100 index of leading British shares was down 1.7 percent, at 5,223.13 while Germany's DAX fell 1.8 percent to 5,688.58. The CAC-40 in France was 1.4 percent lower at 3,785.30.

On Wall Street, the Dow Jones industrial average was down 0.8 percent, at 10,308.56 soon after the open while the broader Standard & Poor's 500 index slid 0.7percent to 1095.74.

Market sentiment, already subdued after U.S. Federal Reserve chairman Ben Bernanke said the world's largest economy was facing "formidable headwinds, was knocked further by the warning from Moody's Investor Services that the United States and Britain must get a grip on their public finances to avoid threats to their top triple-A credit ratings.

In an assessment of eight triple-A countries, Moody's Investors Services said the public finances in both countries are deteriorating considerably and may therefore "test the Aaa boundaries" in the future.

The Moody's report comes a day after rival Standard & Poor's warned Greece that it likely faced a credit rating downgrade and as skepticism grew about how Dubai World plans to restructure its debt.

"It's fair to say that investor sentiment has been rattled and concerns about sovereign credit risks have been escalating," said Neil Mackinnon, global strategist at VTB Capital.

"All in all, it's an unattractive brew for equities," he said.

In addition, a 1.8 percent fall in German industrial output in October, largely as a result of weaker production of machinery and cars, reminded investors that recovery in Europe's largest economy will be gradual. The consensus in the markets was for a 1.1 percent monthly advance.

Trading was expected to become increasingly volatile due to the upcoming year-end _ many investors are looking to book profits made over the nine-month bull run as they settle down for the Christmas break.

The main piece of economic data this week will be Friday's U.S. retail sales figures for November, which will give an early indication into how the Christmas trading period has begun. The state of household spending in the U.S. is key for the global economic recovery _ U.S. consumer spending accounts for around 70 per cent of the nation's economy.

Earlier in Asia, Nikkei 225 stock average lost 27.13 points, or 0.3 percent, to 10,140.47 while Hong Kong's Hang Seng dropped 264.44 points, or 1.2 percent, to 22,060.52.