The FTSE 100 closed down 81.8 points to 6630.9, as metal prices fell and investors waited for a speech by US Federal Reserve chairman Ben Bernanke later today.
Fears over the housing market were also amplified after Home Depot, the world's largest home improvement retailer, cut its profits forecast for the year due to weakness in the US housing market. This comes a day after Bovis Homes reported a sharp slowdown in orders for its new homes.
The FTSE's drop also followed a similar trend in Wall Street, which opened the day on a downward note following some lucklustre results.
Metal prices weighed on the market, with nickel down nearly 9% — the lowest this year. Copper fell slightly but was saved from falling further by a big strike at one of the world's largest copper mines in Chile, reducing world supply. Collahuasi is part-owned by Switzerland's Xstrata and Anglo American. Xstrata was down 112p at £32.48, and Anglo American fell 120p to £32.04.
Nick Moore, an analyst at ABN Amro, said: "The weakness of the commodity prices is feeding through to the miners." He added there was some concern among investors that they would now have to pay a substantial premium in order to get access to potential assets.
BHP Billiton, the world's largest miner, was also down amid talk that it was planning a bid for Alcoa and that it was thinking of teaming up with private equity. Shares in the group dropped 60p to £14.83. Lonmin, the platinum producer, came close behind, down 157p to £41.54.
Wolseley, a supplier of building materials, was also a big faller on the FTSE after Home Depot's announcement, due to its exposure to the US. The company saw its shares drop 26p to £11.54.
Segro, the property firm, fell 7p to 596p, and Land Securities, the real estate investment trust, was down 25p at £17.26.
On the plus side, Unilever topped the list of FTSE 100 risers amid consolidation talk in the sector. This follows the acquisition of Dutch group Numico by France's Danone for £8.3bn yesterday. The deal has sparked hopes of more consolidation in the sector, and there is talk that US billionaire investor Nelson Peltz could be building a stake in Unilever. Mr Peltz has already built stakes in Cadbury Schweppes and Kraft Foods, and it is understood that he influenced the spin-off of Cadbury's American drinks division from the confectionary business. Shares in Unilever rose 31p to £16.47.
Marks & Spencer, meanwhile, was also on the list of biggest risers, despite announcing its sales had been hit by the recent bad weather and interest rate rises. But analysts had expected the news to be worse than it was, and generally breathed a collective sigh of relief. The retailer said like-for-like sales at its stores rose by 2% between April and June, which is its slowest quarterly growth for 18 months, but better than the 1% growth that some had been predicting.
Philip Dorgan, an analyst at Panmure Gordon, raised his price target for M&S from 650p to 675p, saying: "Better-than-expected numbers should see the M&S share price retrace previous losses, despite the poor performance in food. M&S has considerable financial firepower and strong property backing, which we expect will provide further support for the shares." Shares in the group rose 9p to 641.5p.
J Sainsbury was also up on speculation of a bid, and on talk that Robert Tchenguiz, the property tycoon, was selling his stake in the retailer, understood to stand at around 10%. Last month, an investment fund owned by the royal family of Qatar bought shares and now controls 25% of the company. Shares in the retailer rose 6p to 577.5p.
Meanwhile, a series of analyst upgrades helped other stocks. SABMiller, the owner of Peroni beer, was up 5p at £12.78 after Lehman Brothers raised its price target. Analysts said the company was "developing a business model that balances short-term growth with longer-term investment in brands and premiumisation".
They added: "2008 is set to be a year of investment, particularly in the two largest regions: Latin America and South Africa."
Drax, meanwhile, was upgraded to buy from neutral. Analysts said the stock was at a "material valuation discount" to the oil price, which has risen strongly recently. "Drax's share price has historically been closely correlated with the oil price, and is explained by the oil price driving the gas price, which is the marginal fuel cost for power generation in the UK. The recent strength in the oil price has been in contrast to Drax's share price, partly reflecting a shorter-term weakness in cash flow outlook from Drax's recent trading statement and a backdrop of rising coal prices." Shares in the company rose 3.5p to 740.5p.
On the FTSE 250, Arriva was the top riser after it was awarded the Cross Country rail franchise, the UK's biggest rail franchise. According to the company, it covers around 1,500 route miles and calls at over 100 stations. Arriva replaces Virgin Rail, the current operator. Shares in the company rose 56.5p to 770p.
Elsewhere, Dunelm rose 20p to 198p after it posted a positive trading update. The homeware retailer saw a 12.5% rise in sales to £354.7m for the year. Like-for-like sales rose 6.1%. The group said like-for-like sales growth in the last weeks of the year to end June was particularly strong, reflecting soft comparatives due to hot weather and the World Cup in 2006. It added that underlying operating profit would be at the "upper end" of its previous expectations.
But Will Adderley, Dunelm's chief executive, warned that growth in existing stores was expected to be "harder to come by over the next few months" due to recent interest rate rises.
And on Aim, Leyshon Resources, the China-focused mining company, saw its shares rise 1.25p to 28.5p after it announced it had extended its drill programme at its gold project in north-east China by 10,000 metres after "promising early indications".