The German Chancellor told her party conference that Europe faced its "toughest hour since the Second World War" - but that Germany would not support launching 'eurobonds' to solve the crisis.
Instead Ms Merkel said she would push for changes to European treaties to introduce sanctions for financially lax countries and the adoption of a financial transaction tax - with or without Britain.
David Cameron warned that the European Union would be "in peril" unless politicians agreed radical reforms. Speaking at the Lord Mayor's banquet last night, he said markets were "understandably tense" since the eurozone was not "a place to admire and emulate... but a source of alarm and crisis".
Traders sold equities and bonds amid doubts that politicians will act in time to prevent a recession. Eurostat said industrial production in the eurozone fell 2pc between August and September, the biggest monthly fall for two years. The Organisation for Economic Cooperation and Development (OECD) added that the slow-down is likely to continue in all developed economies. France's CAC index fell 1.3pc and Germany's Dax, 1.2pc.
In the bondmarkets, Italy was forced to pay 6.29pc to raise €3bn (£2.6bn) of five-year bonds - a eurozone debt auction record, despite the promise of a new government under Mario Monti. Italy, which still lacks a cabinet, needs to raise a further €46bn in debt before the end of the year.
Panicked traders looking for the next eurozone victim turned on Spain pushing bond yields above 6pc for the first time in three months. Spain faces more hurdles this week with the auction of up to €3.5bn of short term bonds today - and a further €4bn in 10-year bonds on Thursday.
Despite its far lower public debt level levels, traders bet that Spain would follow Italy into "bail-out territory." French bank Societe Generale said: "Spain is now joining Italy on the radar screen". Warren Buffett, the US investor, said bond markets were displaying a "partial run on Europe." British borrowing costs fell to just 2.2pc.
Michel Barnier, the EU markets commissioner, said he wanted to ban credit rating agencies from rating bonds from bailed-out countries. He told French radio that the agencies could lose the "right to rate certain countries for a certain time that are receiving an international support programme from the IMF or European Union." But few could see how the ban could be imposed.
In Athens, a debate over Lucas Papademos' leadership starts in the Greek parliament today. The new premier has to win a confidence vote tomorrow and then prepare next year's draft budget to take to his first showdown with eurozone finance ministers in Brussels on Thursday.
Antonis Samaras, leader of the Greek opposition, warned that he would not support Mr Papademos' interim government for more than three months without elections. His objections are said to be barring the disbursement of the €8bn tranche of international aid to Greece.
The Telegraph
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