Bank shares led stock markets sharply lower Thursday after the president of the European Central Bank dampened hopes that it would take a bigger role in dealing with the debt crisis that has crippled the 17-country eurozone.
While referring to the need for the bank to abide by current rules, Mario Draghi gave a broad hint that he had no intention of increasing bond purchases. His comments came after the bank delivered on market expectations to reduce its main interest rate by a quarter percentage point to 1 percent.
Draghi said he was surprised by some interpretations of his comments last week that "additional steps" would be taken if the 17 countries that use the euro agreed to closer budget controls. Germany and France have proposed a plan on closer fiscal unity that will dominate debate at the EU summit of leaders, which starts later Thursday.
"If the ECB remains unwilling to play a larger role in helping the region through this crisis, it might be difficult for markets to believe a solution is possible," said Benjamin Reitzes, an analyst at BMO Capital Markets. "This is yet another set of minimalist moves when bold action is required."
Stocks have rallied over the past week on hopes that if European governments can agree to tighter spending oversight, the ECB would step up its support for the bond markets. It currently buys bonds in the markets, but only reluctantly and in small quantities.
Following Draghi's comments, stocks turned negative, with bank shares particularly badly hit. European, and in particular German banks, have been additionally hit by fears that a survey into their capital needs will show them needing more money to plug potential holes.
In Europe, Germany's DAX closed down 2 percent at 5,874.44 while the CAC-40 in France fell 2.5 percent to 3,095.49. The FTSE 100 index of leading British shares was down 1.1 percent at 5,483.77.
Italy's FTSE MIB index underperformed its peers, ending over 4 percent down on the day, while the yield on its ten-year bonds spiked 0.58 percentage point higher to 6.47 percent and nearer the 7 percent level that it traded at as recently as last week. Borrowing rates of over 7 percent are considered unsustainable and eventually caused Greece, Ireland and Portugal to seek financial bailouts.
The current bout of worries over the future of the eurozone have been directly related to Italy, which is considered too big to bailout given its euro1.9 trillion ($2.5 trillion) mountain of debt, which is equivalent to 120 percent of its GDP. The recent hopes of a resolution to the euro crisis had helped get those key borrowing rates down.
Bank shares fell by more than the indexes themselves across Europe but the selling was particularly acute among German banks. Commerzbank traded around 9 percent lower.
The euro shed earlier gains too, trading 0.7 percent lower at $1.3300. It had earlier traded as high as $1.3450 after the ECB's rate cut and Draghi's announcement of more liquidity support.
In the U.S., the Dow Jones industrial average was down 1 percent at 12,000 while the broader Standard & Poor's 500 index fell 1.3 percent to 1,244.
On Friday, the focus in the markets will rest on Brussels where the French-German proposal to enshrine tougher budget rules in European treaties will be discussed.
It has already met with some resistance by the European Council, an institution that defines the priorities of the entire 27-nation EU.
Its president, Herman Van Rompuy, has voiced his support for a simpler route _ amending existing rules that apply to the 17 euro countries to avoid the trickier step of requiring every country to approve the new treaty.
The potential for disagreement at the summit weighed on Asian stocks earlier as it had done in Europe and the U.S. on Wednesday.
Japan's Nikkei 225 fell 0.7 percent to 8,664.58, dragged down by weaker-than-expected machinery orders. South Korea's Kospi lost 0.4 percent to 1,912.39 and Hong Kong's Hang Seng shed 0.7 percent to 19,107.81.
But mainland Chinese shares rose, with the benchmark Shanghai Composite Index gaining 0.1 percent to 2,329.82 after losing more than 1 percent earlier in the day to approach an intraday low for the year. The Shenzhen Composite Index gained 0.1 percent to 970.95.
Pamela Sampson in Bangkok contributed to this report.