Breaking a three-day winning streak, the pan-European STOXX 600 closed down 0.9% to post its sharpest one-day drop in a month.
Beijing said Washington had abruptly told it to close its consulate in the city of Houston, a move strongly condemned by China. In response, the Asian country is considering closing the U.S. consulate in Wuhan, a source said.
Energy stocks took the biggest hit, down 2.8% after data showed a bigger-than-expected inventory build-up in the United States, adding to the pressure on oil prices. Royal Dutch Shell, BP and Total SA dropped more than 3%.
U.S. President Donald Trump warned overnight the pandemic would get worse before it got better, while a Reuters tally showed global COVID-19 infections surged past 15 million on Wednesday.
The news deflated the positive mood after European Union members reached a deal on Tuesday over a 750-billion-euro (683 billion pounds) coronavirus recovery fund to help with the bloc's economic recovery from the virus outbreak.
"Markets... swing between despair at the mounting number of COVID-19 cases across the globe, and hope driven by financial stimulus and developments on a potential vaccine," said AJ Bell investment director Russ Mould.
Healthcare stocks marked their worst session in a month, while China-sensitive basic material stocks lost 1.4%.
In earnings, UK home improvement chain Kingfisher had its best day in more than three decades, up 14.6%, after it forecast first-half underlying profit ahead of last year.
Swiss engineering firm ABB Ltd rose 2.8% after saying its order situation could improve in the coming months.
Industrial group Melrose Industries, meanwhile, dropped 14.2% after it signalled it could lay off an unspecified number of employees following losses in the second quarter.
Automakers were hit by a 1.3% slide in French car parts maker Valeo after it swung to a 1.2 billion euros first-half loss.
Expectations for second-quarter corporate profits in Europe have further deteriorated, Refinitiv data shows, as fears grow over the extent of the recession triggered by the pandemic.
Companies listed on the STOXX 600 are expected to report a decline of 58.6% in quarterly earnings, versus 56.2% forecast the week before.
By Sruthi Shankar and Susan Mathew