Investors have been dumping stocks as fresh concerns about the stability of the Italian economy and the future of the Greek bailout package weigh heavily on risk assets.
The FTSE 100 was down 1.3% in early trade on Monday morning, with the French CAC40 and German DAX both falling by more than 1.5%. The volatility index, a key indicator of the market's fear, rose by more than 6%.
The yields on Italian bonds rose to record highs on Friday, as doubts grow over Silvio Berlusconi's government's ability to force through much-needed economic reforms. Italy, the eurozone's third largest economy, has a debt stock that is close to 120% of its gross domestic product (GDP).
"Its not inconceivable that we could be in full crisis mode by the end of this week," Deutsche Bank strategist Jim Reid wrote in a note to clients this morning.
"The situation with Italy feels increasingly like one that has little chance of materially improving until some extreme pressure is put on someone to act. It may not come to a head this week but the signs are not good that we can avoid an extreme situation emerging soon."
The European Central Bank (ECB) has been buying eurozone bonds in an attempt to put a ceiling on borrowing costs and preventing the market crisis from creating deeper economic ones in Italy and Spain, but with costs continuing to rise due to political tussles, the bank has added to the uncertainty in the market by indicating that it will not play this role indefinitely.
Speaking to Italy's La Stampa newspaper, Yves Mersch, an ECB governing council member, said that if the politics was preventing the bank from doing its job of managing monetary policy, it would stop cooperating. "If we observe that our interventions are being undermined by the lacking efforts of national governments, we should ask ourselves about the problem of incentives," he said.
"If the board of the ECB concludes that the conditions that induced it to take a decision no longer exist, it is free to change this decision at any moment."
Despite winning a vote of confidence on Friday, over the weekend George Papandreou, the current prime minister, agreed to stand down and form a government of national unity, headed by a technocrat, that would carry the country into elections in the New Year. Markets are waiting to find out who will lead the new Greek government as it tries to meet the strict conditions of its bailout package and remain within the euro zone. Former European commissioner Stavros Dimas and former ECB vice president Lucas Papademos are thought to be the frontrunners.
Papandreou's position was widely seen as untenable following his decision to put a critical economic rescue package to a public referendum, throwing the entire eurozone crisis response into doubt.
The new government will need to pass a confidence vote and push the austerity package through parliament, all within a timescale constrained by the country's worsening finances. With bailout money from the "Troika" - the European Central Bank, EU and IMF - held up until some form of resolution to the domestic crisis can be found. Evangelos Venizelos, the finance minister, is meeting with his European counterparts on Monday and will be tasked with convincing them that this new coalition is up to the task.