Italy's main index <.FTMIB> touched a two month low with its bank index <.FTIT8300> tumbling 4.5% after the leader of the ruling League party, Matteo Salvini, pulled his support for the country's governing coalition on Thursday and called for fresh elections.
Italy's budget crisis and prospect of ultra low interest rates for longer have already damaged bank stocks' valuations and the fresh political concerns sent the bank index to its lowest since September 2016.
Italian 10-year government bond yields were set for their biggest weekly rise this year.
"It leads to uncertainty because obviously we don't know when it will be possible for Italy to improve their budget because they've only just come to an agreement with Brussels, which could very easily be upended," said Elwin de Groot, Rabobank's head of macro strategy.
Along with drops of more than 1% in most other major indexes, including trade-sensitive German stocks <.GDAXI>, the pan-European STOXX 600 index <.STOXX> gave up 0.8%, in line with a move lower in world stocks <.MIWD00000PU>.
Trump's remarks on a trade deal with China followed a report that said Washington was delaying a decision to allow some trade between U.S. firms and China's telecom equipment maker Huawei again.
This added to worries about an escalation in trade tensions between the world's two biggest economies, which has seen the STOXX 600 give up 1.7% over the week as investors worry over a prolonged impact on global economic growth.
Sectors most exposed to China and trade issues, such as technology <.SX8P>, basic materials <.SXPP> and automakers <.SXAP>, led losses in Europe along with banks <.SX7P>.
"It is a risk-off sentiment but investors aren't desperate yet... its more like the realisation that we are in for a rough ride," Rabobank's Groot said.
However, losses on London's FTSE were limited by a rally in healthcare stocks and a 7.2% surge in advertising company WPP after it reported improved second-quarter trading.
The rise in the healthcare index <.SXDP> came after strong results from Hikma Pharma and Carl Zeiss and was also helped by a 2.6% rise in Bayer.
The pound was hit by data showing Britain's economy experienced a shock contraction in the second quarter in a severe hangover from a pre-Brexit stockpiling boost, boding poorly for Prime Minister Boris Johnson as he gears up to leave the EU in October with or without a departure agreement.
(Reporting by Agamoni Ghosh, Shreyashi Sanyal and Susan Mathew in Bengaluru; Editing by Bernard Orr and Kirsten Donovan)
By Susan Mathew and Shreyashi Sanyal