LONDON: Europe's main stock markets plunged on Tuesday with banking shares leading the way, as investors awaited signals on the outlook for the US economy from a meeting of the US Federal Reserve.

The Fed is widely expected to hold its near-zero interest rate policy unchanged when it announces its rate decision on Wednesday but traders will be looking out for hints on the timing of any rate hike and on the recovery.

"Traders continue to take a breather to asses the sustainability of the economic recovery," said analysts at US investment firm Charles Schwab Co.

Wall Street "is also grappling with what the Federal Reserve's monetary policy meeting -- which begins today -- will reveal about the FOMC's economic outlook and the duration of its accommodative policy stance," they said.

Investors were also digesting mixed data showing a sharply better-than-expected gain in productivity by US businesses but a decline in hourly compensation that pointed to further pressure on consumer spending.

London's benchmark FTSE 100 index of leading shares dropped 1.08 percent, the Paris CAC 40 fell 1.38 percent and the Frankfurt Dax plunged 2.44 percent.

Elsewhere in Europe, Geneva was down 0.96 percent, Brussels lost 1.40 percent, Madrid fell 0.83 percent and Milan fell 1.43 percent.

On Wall Street the Dow Jones was down 1.03 percent in early afternoon trading while the tech-heavy Nasdaq index had dropped 1.26 percent.

Many traders cashed in profits from a recent rally on bank stocks and mining companies also suffered because of a decline in commodity prices, while insurance firms gained ground amid signs of increased takeover activity.

French bank BNP Paribas was down 1.25 percent at 53.67 euros, while Britain's Lloyds Banking Group lost 7.05 percent to 90.99 pence on reports that it planned to raise 15 billion pounds (17.6 billion euros, 25 billion dollars).

In Frankfurt, luxury fashion chain Escada lost 33.48 percent to 1.55 euros after the company said on Monday that it could declare bankruptcy this week if a last-ditch debt restructuring deal with creditors is not approved.

Asian markets had closed higher earlier on Tuesday as investors shrugged off disappointing Chinese data to maintain a broadly optimistic view.

China's industrial output expanded 10.8 percent in July from a year earlier, official figures showed, but the market had expected a sharper rise.

Exports fell 23 percent compared to a year earlier. However, investors took a sharp fall in new yuan lending as a signal the central bank may not further tighten monetary policy. Shanghai gained 0.46 percent while Hong Kong added 0.69 percent.

Tokyo closed up 0.58 percent as investors showed little reaction to a decision by the Bank of Japan to hold its key interest rate steady at 0.1 percent, as expected.