The US service sector contracted in January for the first time in almost five years, a survey has shown.
The fear is that Americans will stop spending as job losses increase
The Institute for Supply Management's (ISM) index of service sector business activity fell to 41.9, from 54.4 for the previous month.
The dividing line between growth and contraction is 50. The unexpectedly weak reading stoked fears that the US would fall into recession.
Wall Street shares tumbled on the news, while the UK's FTSE 100 fell 2.6%.
This is the first contraction of business activity in the service sector, which accounts for two thirds of US economic growth, since March 2003.
And it marks the lowest level of activity since October 2001, the month following the 11 September terrorist attacks.
The ISM report also showed a steep decline in inventories, employment and new orders, while operating costs increased.
"The overall indication in January is that non-manufacturing has come to the end of a long-term period of growth," said Anthony Nieves, chairman of the Institute for Supply Management's non-manufacturing business survey committee.
Data out earlier showed that the service sector in the 15-nation euro bloc was also suffering, but still registered growth for January.
The news sent global stock markets and oil prices tumbling as traders took it as a further sign of an impending US recession.
"On face value, this index tells you that this recession we are heading into will be worse than the one in 2001," said Christopher Low, chief economist at FTN Financial.
All three stock market indexes in the US sank, with the benchmark Dow Jones shedding 370 points, or 2.9% at 12,265.1, while the broader S&P 500 index and technology-heavy Nasdaq also declined sharply.
Across the pond, the UK's FTSE 100 index fell 2.6% to 5,868, Germany's Dax shed 3.4% to 6,765, while in Paris, the Cac 40 index dropped almost 4% to 4,776.8.
Oil prices were hit on fears that a recession in the US would hurt energy demand.
US light crude fell $1.61 to $88.41 a barrel, while London Brent fell by $1.65 to $88.82 a barrel.
Last week US Labor Department figures showed the first decline in employment since August 2003, shocking economists.
The fear is that an increase in unemployment will further curb US consumer spending, which will weigh heavily on economic growth despite sharp US rate cuts in the past two weeks and tax incentives from the White House.
But some analysts cautioned about overstating the gloomy prognosis for the world's largest economy.
"We do have considerable stimulus from both the Federal Reserve and from a major cut in taxes in the middle of the year so the economy could experience a decent second half", said Cary Leahy, economist at Decision Economics.
"But it's hard not to deny that the start of 2008 is somewhere between disappointing and bad," he added.