The blue-chip FTSE 100 index fell 12.33 points, or 0.2 percent, to 5,521.54 points, having slumped by 2.1 percent on Monday.
Banks, which are exposed to potential losses in debt-ridden euro zone countries such as Spain and Greece, were among the worst-performing stocks, with Royal Bank of Scotland topping the FTSE 100's loser board by falling 2.2 percent.
The crisis has resulted in sovereign bailouts for Greece, Ireland, Portugal, while Cyprus has requested similar aid. Fears persist that Spain could need a full sovereign rescue deal in addition to up to 100 billon euros already agreed for its ailing banks, while Italy's borrowing costs have also risen as the crisis risks spreading further through the region.
"The cat's been thrown among the pigeons because of the Spanish and Italian bond yields," said Hartmann Capital trader Basil Petrides. "I really don't want to participate in the market because of the uncertainty."
FTSE BREACHES KEY TECHNICAL SUPPORT LEVEL
Traders said the fact that the FTSE 100 had fallen below its 200 day simple moving average -- a key technical indicator -- had given further impetus to investors to sell.
The 200-day moving average level has been at around the 5,600 point mark over the last month, and traders had been prepared to buy the index in recent weeks as it remained above that level.
"Yesterday's price action was significant in that it took the FTSE back through its short-term uptrend in a decisive manner," Charles Stanley technical analyst Bill McNamara said in a research note.
The failure of the FTSE 100 to remain above the 5,700 level was another negative factor, he said.
"At the same time, it has retreated below its 200-day moving average and the combined effect of the double failure is to confirm the failure at resistance (at 5,700 points or so) and set the index on a course where further weakness has become a realistic expectation," McNamara wrote.
Earlier on Tuesday, equity markets had rallied after data which showed China's flash factory purchasing managers index had risen in July to its highest level since February.
But traders said they would use any such rally to quickly book profits by selling equities, due to fears that markets could soon fall back due to the underlying weak economic backdrop caused by the European economic crisis. "We're looking to sell into any signs of strength. We're going to be jittery all summer. It looks to me as if Greece could still leave the euro zone and the Spanish situation is extremely difficult," said JN Financial senior trader Adrian Redmond.