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By Jeremy Gaunt, European Investment Correspondent
Wall Street looked set for a poor start. The dollar was stronger, however, with Britain's pound plunging more than 3.5 percent on worries about the UK's banking system.
World stocks as measured by MSCI <.MIWD00000PUS> were down 1.2 percent. Emerging markets equities <.MSCIEF> lost 2.2 percent and Japan's Nikkei average <.N225> closed down 2.3 percent.
European shares fell despite a stronger-than-expected ZEW analyst and investor sentiment index, which rose to -31.0 from -45.2 and in comparison to so -44.0 expectation.
The FTSEurofirst 300 <.FTEU3> was down 0.7 percent.
U.S. stock futures were down sharply as Wall Street prepared to re-open after the Martin Luther King Jr holiday and the world's attention was focused on Obama's inauguration.
Obama is to push a huge stimulus package to move the world-leading U.S. economy out of its severe slump.
"The market is refocusing on the bigger global picture," said Justin Gallagher, head of Sydney sales trading at ABN AMRO, pointing as well to expectations for weak corporate earnings results in coming weeks.
"Clearly the market today continues to factor in more disappointment and certainly, despite the inauguration of Obama ... the market is looking past that now and realizing just how big a mess the global economy is in," he said.
Banks were in focus after Royal Bank of Scotland
RBS was up 11 percent, but only after having plunged 67 percent on Monday.
"After yesterday's carnage the smoke is still hanging over the market," said Justin Urquhart Stewart, director at Seven Investment Management.
"People talk about the nationalization of the banks. That's almost beside the point, like interest rate cuts. What we have is the nationalization of banking policy."
POUND PLUNGES
The pound plunged to a 7-1/2 year low against the dollar on the banking sector woes, while the euro dropped to a six-week low against the U.S. currency, weighed by worries about the state of the euro zone economy.
Sterling was 3.4 percent down against the dollar at $1.3965, around the lowest level since July 2001, while the euro fell around 1 percent to $1.2990, having hit a six-week low of $1.2923.
Fears about the outlook for the euro zone economy weighed on the euro after the European Commission on Monday issued a grim 2009 forecast and Standard and Poor's cut Spain's debt ratings.
"The Obama euphoria is dollar positive and the biggest casualty of this is sterling because by contrast sterling sentiment is really bad," Commerzbank currency strategist Antje Praefcke said.
European sovereign debt sold off as worries over countries' economic health grew in the face of credit rating downgrades and the mounting debt piles needed to fund financial sector bailouts.
On credit markets, the cost of insuring against default by some countries hit record highs.
"Markets are fretting about the level of supply to finance the ever-increasing debt issuance needed to support the banking sector, especially in the U.S. and UK," said Nick Stamenkovic, a strategist at RIA Capital Markets.
German Bunds outperformed their U.S. and UK counterparts with 10-year yields half a basis point higher at 2.998 percent and March futures 6 ticks lower at 125.12. The short-end performed better, with 2-year yields 3.3 basis points lower at 1.499 percent.
In the wider market, the premium investors demand to buy 10-year Belgian, Dutch and Greek government bonds rose to a fresh record, according to Reuters data, driven by downgrade worries.
(Additional reporting by Rebekah Curtis, Rafael Nam, Jessica Mortimer and Kirsten Donovan; Editing by Ian Jones)
