A senior police officer quoted by AFP says British police have arrested 21 people in connection with the plot, while Sky News earlier reported that 20 planes were targeted.
A British police later told Reuters that liquid chemical devices were believed to have been involved in the plot.
"It would be safe to assume it is believed it involves some kind of liquid chemical," the source said.
Police have not confirmed the reports however passengers with infants were required to taste bottles of baby milk and liquids were being removed from passengers before they were being allowed on British flights.
British airports operator BAA has since requested the suspension of all flights due to take off for Heathrow, the National Air Traffic Services said.
KLM, Alitalia, Iberia, Olympic Airlines, Air France, Lufthansa, Air Berlin and British Airways have cancelled flights.
Qantas airlines says it will enforce tougher security checks and baggage controls for all flights leaving from and transiting through Britain due to the heightened terror alert.
"Qantas has begun contacting customers likely to be affected by the new security measures in Australia, its Asian hubs and in the UK and Europe," Qantas said in a statement.
Joint operation
The plan was uncovered in a joint operation by Scotland Yard's anti-terrorist branch and security service, the Metropolitan Police said, later adding the foiled plot was "an attempt to commit mass murder on an unimaginable scale".
Deputy Commissioner Paul Stephenson, from London's Metropolitan Police, told a news conference that officers were confident the operation had disrupted a bid to cause "untold death and destruction".
In an earlier statement, Scotland Yard said their investigation into the alleged plot was a "major operation" which would be "lengthy and complex".
"We would like to reassure the public that this operation was carried out with public safety uppermost in our minds. This is a major operation which inevitably will be lengthy and complex," the statement said.
Britain's Home Secretary John Reid said it was "very significant plot" aimed at bringing "down a number of aircraft through mid-flight explosions".
"We are doing everything possible to disrupt any further terrorist activity," he said in a statement. "This will mean major disruption at all UK airports."
The security alert comes 13 months after four British Islamist suicide bombers killed 52 people and injured about 700 on London's transport network.
In a speech, Mr Reid said Britain was in the most sustained period of severe threat since the end of World War II and warned there was no room for complacency.
"We don't think that it was planned to happen today," a police source told Reuters.
"We had intelligence and we had to move against what was a planned attack.The plan was to take a ready-made explosive device rather than something which would be made up on board.”
UK threat level 'critical'
Britain's security services raised the UK threat level to 'critical' - the highest possible – meaning "an attack is expected imminently and indicates an extremely high level of threat to the UK,” according to MI5’s website.
The United States government also raised its threat level to the highest level for commercial flights from Britain to the United States, The Associated Press reported.
The US also stepped up the general threat level for all flights within the US or entering the country.
"We believe that these arrests (in London) have significantly disrupted the threat, but we cannot be sure that the threat has been entirely eliminated or the plot completely thwarted," said US Homeland Security Secretary Michael Chertoff.
He announced the threat level for flights from Britain to the United States had been raised to the highest "severe or red" level.
The department later raised the threat level for all US-bound planes.
Security immediately tightened
Security was immediately ordered tightened at British airports and additional security measures have been put in place for all flights.
The Department for Transport says passengers will not be allowed to take any hand luggage on to any flights in the UK.
Only the barest essentials - including passports and wallets - will be allowed to be carried on board in transparent plastic bags.
British Airways said no hand baggage would be allowed on any of its planes leaving British airports.
It said no electrical or battery powered items would be allowed in the cabin, including laptops and mobile phones.
British Airports Authority said all passengers on flights to the United States would be subject to a secondary search at the boarding gate and all liquids would also be removed.
"We hope that these measures, which are being kept under review by the government, will need to be in place for a limited period only," the Department for Transport statement said.
Australian travellers warned
New advice issued this afternoon by Australia’s foreign affairs department advised Australians in the UK or thinking of travelling to the UK to exercise caution and monitor developments because of the risk of terrorist attack.
"We advise you to exercise caution and monitor developments that might affect your safety because of the risk of terrorist attack," the new DFAT advice says.
"Pay close attention to your personal security and monitor the media for information about possible new safety or security threats."
Hand luggage 'weak spot'
Independent British terrorism expert Paul Beaver said hand luggage was a weak spot in airport security.
"A laptop computer can carry enough explosives to blow up an aircraft," he said. "Hold baggage and cargo can be sniffed for explosives. You can't do that for hand luggage at the moment. The technology is there, but it's time consuming and expensive."
Mr Beaver said the nature of the alleged plot suggested a connection to al Qaeda.
"In the last two months al-Qaeda promised that it would avenge Iraq and Afghanistan by attacking British and American aviation assets - I see a direct link with that," he said.
Security analyst Rohan Gunaratna of the Singapore-based Institute of Defence and Strategic Studies, said Al-Qaeda was the only group capable of planning such an attack.
"The only group that has the intention and the capability to mount coordinated simultaneous attacks of this magnitude is Al-Qaeda and cells that are very much motivated by the ideology of Al-Qaeda," Mr Gunaratna told Sky News.
Mr Gunaratna said in the past two years British police had disrupted four Al-Qaeda inspired cells that were planning major terrorist attacks in the UK.
"So it is reasonable to assume that this set of cells that were disrupted in the past 24 hours belong to that category of Al-Qaeda inspired cells," he said.
Britain has come under fire from Islamist militants for its military campaigns in Iraq and Afghanistan.
News of the arrests and heightened security threat came amid high international tension over the war in Lebanon and the week Prime Minister Tony Blair headed on holiday to the Caribbean.