Travel and leisure companies such as British Airways were sold back after British police said they had foiled a bomb plot to blow up transatlantic airlines. But, after an initial tumble, the broader London market finished well off its worst levels.
Vodafone saw no respite, however, as a profit warning from Deutsche Telekom also triggered fears that mobile operators face an escalating price war.
The FTSE 100 Index closed lower by 37.1 at 5823.4, having tumbled as much as 1.8 per cent after about an hour of trading, losing 107.9 to 5752.6. Meanwhile, sterling and UK gilts eased from earlier peaks after a knee-jerk search for safe havens at the start of the day
That follows officials in London and Washington claiming they had uncovered a plot to explode up to 12 flights from the UK to the US, using liquid chemical bombs. Britain and America both raised their terrorism security alerts to the highest levels.
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Despite the news, Wall Street markets held steady after four straight falls, with the Dow Jones Industrial Average adding 4 to 11080. Strong earnings from Dow-listed insurance company AIG combined with lower crude prices, which fell on the theory that fewer planes in the sky would mean more fuel on the ground. A barrel of New York crude traded at $75.15, down $1.20 from late yesterday.
Trade remained nervy on both sides of the Atlantic, however, after the Dow reversed in the last hour of yesterday's session to finish lower by nearly 100 points.
Shares have been under pressure after the Federal Reserve on Tuesday paused its two-year campaign of rate hikes but indicated that it may not have finished its tightening cycle -- a message some commentators interpreted as a vote of no confidence for the world's biggest economy.
World markets were further unsettled by South Korea unexpectedly raising interest rate to a five year high. That mirrors recent moves by nations including the UK, India, China, Australia and the euro zone, as central bank chiefs try to combat inflation from soaring commodity prices.
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On the FTSE. British Airways fell 19.75p to 370.25p, a loss of 5.1 per cent. The airline grounded all short haul flights through its Heathrow hub, which was not accepting incoming airlines not already in the air.
Security at all UK airports has been increased and additional security measures have been put in place for all flights, including a ban on all hand luggage. For the foreseeable, the only things allowed in the cabin of airlines leaving the UK are wallets, travel documents such as passports, and the bits and bobs needed to pacify babies.
EasyJet fell 8.75p to 414p and Ryanair was down €0.11 at €7.42. Ferrovial, the Spanish firm that bought Heathrow operator BAA earlier this year, weakened 1.7 per cent on the Madrid exchange amid concern about what a carry-on ban will do to airport shop sales.
Leisure stocks matched the declines, with InterContinental Hotels retreating 26.5p to 839p and London-listed cruise ship operator Carnival off 50p to £20.37. Car hire firm Avis Europe lost 3.5p to 63p.
Beyond the obvious short-term implications for passenger numbers, the airlines could suffer because of costs for increased security and compensation. Both BA and the low-cost carriers increasingly rely on online check-in facilities, which have been suspended. Ryanair faces a further problem because it recently introduced charges for checking in bags.
Some saw the cost to BA alone as comparable to its baggage handling strike last year, which is estimated to have hit profit by up to £40 million.
Nevertheless, analysts remained upbeat, as their paymasters demand: Panmure kept "buy" advice on BA and Citigroup called falls in EasyJet a buying opportunity.
"We see a likely congestion (and) cancellation cost hit, but little revenue impact and would argue that the low ratings of the sector means that negative sentiment should already be priced in," said Deutsche Bank. Travel restrictions do not usually reduce the propensity of people to travel, it argued, "because the net effect is to make air travel safer".
The German broker did concede that the scare could drag on future volume growth as travellers cancel non-essential trips, or favour trains and automobiles to planes. But flag carriers such as BA are not relying on passenger volume growth to improve profits, Deutsche reckoned.
"Following (September 11) the entire sector significantly de-rated and in our view has not since re-rated. Therefore we believe that although sentiment is negative, we do not see why the sector should see a further de-rating," the broker concluded.
Paris-based bank Exane BNP Paribas provided the lone voice of panic, with its sell side analysts sticking to its "underperform" recommendation on BA.
The "situation points to the vulnerability of the UK as a terrorist target and the failure of a sizeable number of discontents in the UK to buy into the legal and political system," Paribas reckoned. "While other large European countries also face this issue, it is in the UK where there seems to be the greatest willingness to take criminal action."
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Telecoms companies such as BT and Vodafone also featured on the FTSE faller board after Deutsche Telekom's second quarter earnings missed expectations.
The German carrier also warned on profits for the next two years, saying its home market had gone ex growth. DT bought its guidance down by 10 per cent for the current year and undershooting forecasts by 20 per cent for 2007.
BT fell 6p to 243.5p and Vodafone, which competes with Telekom's T-Mobile division, retreated 4.5p to 112p. Telekom said today that T-Mobile would become a price leader in Germany to stem market share loss.
"The scale of DT's profit warning should prompt the next round of cuts to Vodafone estimates," said JP Morgan, which cut its rating on Vodafone to "underperform" from "neutral". It noted Telekom's guidance that it will price its contract bundles below €0.10 a minute, some 60 per cent below both its own and Vodafone's charge.
The Wall Street broker argued that, while Deutsche Telekom was previously fighting to reinvigorate growth, it was now simply intent on keeping its head above water. If Vodafone responds, it will hit consensus forecasts by about 5 per cent, it argued.
"All this reinforces high forecast risk to European mobile, with downside risks especially severe for operators such as Vodafone that enjoy high market shares and premium price points," JP Morgan told clients. "Vodafone's recent argument that investors should expect tariffs to stabilize after 12 months of price cutting, with more positive price elasticity starting to feed through, is now looking somewhat outdated."
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International Power was the only blue chip to consistently beat the day's weak trend, closing up 10.25p to 316.5p after its first half results topped expectations. The generator said profits from operations rose 69 per cent to £392 million thanks to higher wholesale prices in Europe.
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Smiths Group, which makes explosives detectors and Boeing airline parts, slid 41.5p to 840p after an in line trading update came with a caution on the effects of a weak dollar.
The company said that, despite suffering a £7 million hit in the second half because of currency translation effects, improved end markets meant it still expects to deliver annual earnings matching City expectations. Management also said that, at current levels, the dollar would continue to hold back progress in 2007.
Every 1 per cent move in cable shifts Smiths' profit by £2.3 million before tax, which totalled £400 million in its last fiscal year.
Engine maker Rolls-Royce was down 9.5p to 412p in tandem, while defence and aerospace contractor Cobham slipped 2.5p to 155.5p.
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Wolseley, a plumbers' merchant making more than half its revenue in dollars, lost 23p to £10.74. The shares took a further knock from downbeat news from Toll Brothers, a US house builder, which said overnight that third quarter sales fell as the American homes market comes off the boil.
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Among the mid-caps, Enodis fell 14.5p to 165p after the industrial kitchen equipment maker rejected requests from US rival Middleby for access to its books. The fryer and fridge supplier yesterday said takeover talks with Manitowoc, another American peer, had collapsed, sending its shares lower by 16 per cent.
Middleby, which has had a 195p per share bid approach rejected, had asked Enodis to help it seek an extension to Takeover Panel's "put-up-or-shut-up" deadline of August 14. Enodis said no, and repeated that Middleby's 195p offer significantly undervalues its prospects.
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Spirent added 1.75p to 43.25p even after the telecoms equipment firm trimmed forward guidance and delivered a mixed set of interim results. Anything Spirent says at the moment plays second fiddle to the possible intentions of Sherborne Investors, an activist shareholder that has built a 9.6 per cent stake in the group over the past week or so.
Spirent posted sales up 9.2 per cent to £138.2 million, a fraction ahead of expectations, but weak profit margins meant profit was merely in line, at £6.1 million before tax. Spirent said the margin drag would continue into the second half, although some operating costs would drop out of the mix.
Cazenove cut its forecast for Spirent's 2006 sales and earnings per share by 3.6 per cent and 6 per cent respectively, at £77 million and 1.6p. There was no new information on the company's restructuring programme, unveiled on June 29; Sherborne is rumoured to be pushing the company to increase its cash return plans.
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On broker watch:
UBS cut Whitbread to "reduce" from "neutral".
Seymour Pierce cut Cable & Wireless to "underperform" from "outperform".
ING rated Standard Life a "buy" in new coverage.
Sandford Bernstein raised ITV to "outperform" from "peer perform".
Cazenove cut house builders Barratt, Bellway, Persimmon, Redrow, Wilson Bowden and Wimpey all to "in-line from "underperform".
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