It's believed the alleged plotters were planning to blow up ten planes mid air over the Atlantic using liquid explosive brought onboard on their hand lugage.
A US official said Continental Airlines, United Airlines and American Airlines flights were the focus of the planned attacks.
Britain and the US immediately raised their nationwide terrorist alerts to the highest possible level.
British police arrested 24 people in connection with the plot during overnight raids in London, southeast England and Birmingham.
According to a Muslim community leader one of the people arrested is a young mother with a six-month-old baby.
“We are confident we have disrupted a plan by terrorists to cause untold death and destruction," said London police's Deputy Commissioner Paul Stephenson. "Put simply, this was intended to be mass murder on an unimaginable scale."
Mr Stephenson said the plot had "global dimensions" and that police were cooperating with foreign agencies.
British Interior Minister John Reid said police were confident the main players had been detained.
"The police, acting with the security service MI5 have carried out a major counter-terrorism operation overnight to disrupt an alleged plot to bring down a number of aircraft through mid flight explosions," Mr Reid said.
"Had this plot been carried out, the loss of live to innocent civilians would have been on an unprecedented scale. The police operation is complex, and it is ongoing."
Security sources said they had been watching the suspects for eight month and while they did not rule out an al-Qaeda link, direct involvement by the militant group was played down.
Pakistan link
Britain's domestic Press Association news agency said the 24 people arrested were mainly of Pakistani origin.
Another security source said intelligence agencies in Islamabad had provided key leads to Britain's secret service that enabled them to uncover the plot.
"The actions that have been taken in London were made possible only with the close cooperation between Pakistani and British intelligence," the official said.
"Pakistani intelligence cooperated and provided vital information that led to these actions."
Pakistan came under the spotlight after the suicide attacks on the London transport system when it emerged that some of the British-born bombers had attended Islamic religious schools there.
Pakistani authorities said they had made several arrests in connection with the plot, including at least three people linked to Al-Qaeda.
Foreign office spokeswoman Tasnim Aslam would not say how many were held but said the arrests were coordinated with the detention of 24 suspects in Britain.
The arrests in Britain "followed active international cooperation between Pakistan, the United Kingdom and the United States," she said.
Liquid explosive
US Homeland Security Secretary Michael Chertoff said the plot was in the final stages of planning before execution.
"The terrorists planned to carry the components of the bombs, including liquid explosive ingredients and detonating devices, disguised as beverages, electronic devices or other common objects," he said.
The US television network ABC news quoted unnamed American officials saying five suspects were still on the loose and being eagerly hunted.
The network also reported that at least two of the suspects had prepared martyrdom tapes. British police declined to comment.
US officials said they saw signs of al-Qaeda's methods, but it was too early to draw conclusions on whether the global militant group was involved.
Airports worldwide tightened security measures on passengers and luggage travelling to and from Britain and the United States, causing travel delays and flight cancellations and leaving many passengers stranded.
Airport chaos
London's Heathrow airport, one of the busiest in the world, was badly hit.
Passengers on all planes leaving British airports, including on domestic and transit flights, were banned from taking hand luggage on board other than essential items such as money, tickets, keys, medicine and glasses.
Apart from baby milk, which had to be tasted, all liquids were forbidden.
Draconian hand luggage restrictions similar to those imposed by London and Washington have been introduced at airports around the world.
All passengers travelling from Australia to the United States will be forced to comply with heightened security measures.
Qantas says passengers to the US will not be allowed to carry liquids and gels in their hand luggage. This includes all drinks, shampoos, sunscreen, toothpaste and hair gels.
The only exceptions are baby formula, juice for a child or medicine. Passengers' footwear will also be screened.
Qantas has warned passengers to allow more time to check in to their flights.
The airline says the security measures were introduced following instructions from the US Department of Homeland Security.
Attorney General Philip Ruddock says there's no specific intelligence that anyone is planning a similar type of attack in Australia.
Mr Ruddock says while there's no official raising of the terror alert at airports there is a heightened awareness.