European shares fall as debt fears intensify

LONDON: European shares fell sharply on Monday, and were testing key technical lows, with the financial sector among the biggest fallers as long-awaited bank stress tests result served only to intensify worries about the regional debt crisis.

At 1119 GMT, the FTSEurofirst 300 index of leading shares was down 1.2 percent at 1,074.28 points.

In results announced after Friday's close, the failure of eight small banks was in line with market expectations but the test was not considered strict enough by many in the market and also failed to factor in the potential for a Greek sovereign default.

Added to the failing banks, a further 16 were close to failing the test -- by seeing their core capital slide below 5 percent in the face of a prolonged recession -- and all of them may need to take action to shore up their balance sheets.

The STOXX Europe 600 Banking Index fell 1.7 percent. Heavyweight fallers included Italy's Intesa SanPaolo and UniCredit , down 3.9 and 3.6 percent respectively, with renewed worries about Italy's sovereign risk

Insurers, many of which are also exposed to the euro zone crisis, fell, with France's Axa down 3.7 percent, taking its decline in July to more than 16 percent.

"I haven't got much confidence in the stress tests. Maybe more should have failed," Caroline Vincent, fund manager at Cavendish Asset Management, said.

"Something radical needs to be done to address the debt issues for the peripheral countries. There is value with stocks trading at single digit PEs but with sentiment as negative as it is now undoubtedly it will fall further, because of what's happening on the macro side."

Italian and Spanish 10-year bond yields rose sharply on Monday, as contagion spread on investor concern over the failure of policymakers to quickly resolve the region's debt crisis.

Euro zone leaders will meet in Brussels on July 21 to discuss a second bailout package for Greece and the financial stability of the euro area, European Council President Herman Van Rompuy said on Friday.

The Thomson Reuters Peripheral Eurozone Countries Index was down 2.2 percent. The Thomson Reuters Peripheral Eurozone Banking Index was down 2.7 percent.

The euro's strong correlation with stocks, which often makes it a gauge of "risk-on/risk-off" trade, has hit a five-month high. The 66-day rolling correlation between the euro and the Euro STOXX 50 index has risen to 0.838, its highest since mid-February.

The euro was down 0.6 percent, against the dollar while the Euro STOXX 50, the euro zone's blue chip index, was down 1.6 percent.

The dollar's strength hit base metals prices, and the The Stoxx Europe 600 Basic Resources Index fell 1.5 percent. However, gold hit new highs.

TESTING INDEX LOWS

The pan-European index, down more than 4 percent in 2011, is near the bottom of a range defined by the 2011 high it hit in mid-February, 1,190.51 points, and the low of mid-March, 1,066.62. Technical analysts said it was now reaching a critical point.

"The reversal has taken the index back.... (near) the June lows (at 1,074) and a further examination of those lows now appears to be a realistic expectation. In fact, the March lows don't look entirely safe either," Bill McNamara, technical analyst at Charles Stanley, wrote in a note.

Corporate news also contributed to the market's decline.

Among individual shares, compressor and machinery maker Atlas Copco fell 6.9 percent after posting second-quarter earnings below market expectations

BP, which reports next week, fell 1.1 percent after a breached pipeline at one of its Alaska oilfields spilled a mixture of methanol and oily produced water.

U.S. debt issues also loomed large for investors. With five days remaining before President Barack Obama's deadline for a deal to raise the U.S. debt ceiling, Republicans and Democrats have yet to agree on a big plan to cut the nation's deficit and raise its debt limit in time to avoid an unprecedented U.S. default. – Reuters