European shares dropped 2.5 per cent yesterday in a broad equities selloff, ending at their lowest closing level in two weeks on renewed credit fears, a steep jump in core US prices and weak US housing data.

The FTSEurofirst 300 index of top European shares closed 2.5 per cent lower at 1,159.39 points, after falling to as low as 1,159.05, the index's lowest level since August 5.

Banks took a beating as investors worried about the fate of the financial sector following a Barron's report that suggested the US government may have no choice but to nationalise mortgage finance giants Freddie Mac and Fannie Mae.

Royal Bank of Scotland sank 5.9 per cent, Fortis tumbled five per cent and Commerzbank shed 4.9 per cent. The DJ Stoxx European bank index fell 4.3 per cent.

Data showed yesterday that US wholesale prices jumped in July at the fastest year-on-year rate since 1981, while home builders cut back on construction as they worked through a glut of unsold homes.

"Inflation will continue to be a concern, but the real worry is still in the housing market," said Franz Wenzel, strategist at AXA Investment Managers in Paris.

"We will continue to have bleak data for a while. We know from the Japanese example that a housing slump usually lasts for longer than economists can think of."

The US producer price index, which measures prices at the factory door, climbed 1.2 per cent after a 1.8 per cent gain in June. So-called core producer prices, which exclude food and energy, jumped 0.7 per cent in July after a 0.2 per cent June increase.

Economists polled by Reuters had expected producer prices to rise just 0.6 per cent in July, and had forecast that core prices would be up only 0.2 per cent. A sharp decline in oil prices since mid-July led many investors to conclude that inflation pressures were subsiding.