The German DAX sank as much as 5% before cutting some losses to close down 4.2% at its lowest in five months. The precise measures were still subject to negotiation, with sources saying the government had agreed to shut bars and restaurants from Nov. 2.
The pan-European STOXX 600 index fell 3% in its sharpest one-day drop in five weeks. France's main index dropped 3.4% ahead of a televised address by President Emmanuel Macron at 8:00 pm (1900 GMT) when he is expected to issue stay-at-home orders.
"News of renewed lockdown measures... will add further to growth concerns in the region, at a time when mobility indicators have already started to fall and survey indicators moderate," said Mohammed Kazmi, portfolio manager for UBP's Absolute Return Fixed Income team.
"This will likely drive European Central Bank President (Christine) Lagarde to remain dovish in her comments in the press conference tomorrow, laying out the path for more easing to come down the line."
Lagarde is due to speak at 1230 GMT on Thursday.
Ahead of that, the European Commission proposed new tax and trade measures on Wednesday to fight the pandemic around the EU, while sources said Germany aims to increase its debt plans next year to finance new coronavirus aid measures.
All sectors in Europe were firmly in the red, with the economically sensitive autos sector leading losses, down almost 5%.
U.S. stocks also tripped with surging cases there weighing on sentiment and no stimulus package in sight just a week ahead of the U.S. presidential election. [.N]
The downbeat mood overshadowed a batch of upbeat quarterly results from European companies, with Deutsche Bank AG and retailer Carrefour down despite upbeat results.
German online takeaway food company Delivery Hero and industrial technology group Hexagon, however, were among the rare gainers after robust earnings reports.
Aero-engine maker Rolls-Royce, meanwhile, soared 12.5% a day after shareholders approved a 2 billion pound ($2.61 billion) rights issue to bolster its finances.
(Reporting by Sruthi Shankar in Bengaluru; Editing by Sriraj Kalluvila and Hugh Lawson)
By Sruthi Shankar and Susan Mathew