European shares hit a five-week low in choppy trade on Thursday as rising sovereign euro zone bond yields raised concerns the currency block's debt crisis could spread to some of the larger and stronger economies.
Spain's borrowing costs jumped to 14-year peaks at an auction of 10-year debt, while its 10-year bond yield premium over German benchmarks rose to its highest in the euro's history. In France also, the cost of borrowing over two and four years jumped by around half a percentage point.
Banking shares, which have slumped more than 35 percent so far this year due to their huge exposure to euro zone sovereign debt, were among the top decliners. The sector index fell 2.6 percent, led by KBC Groep, down 11.3 percent, and Lloyds, down 5.2 percent.
At 1230 GMT, the FTSEurofirst 300 index of top European shares was down 1.6 percent at 954.39 points after falling as low as 950.94, the lowest since early October. Across Europe, France's CAC 40 fell 1.7 percent, and Spain's IBEX was down 1.1 percent.
The higher bond yields indicated that investors remained doubtful about the ability of European policymakers to take proactive and decisive steps necessary to tackle the crisis.
The change in political leadership that we have seen in the likes of Italy and Greece does very little to change the underlying problems. Reform agendas are a step in the right direction, but that will take time to filter through and won't be the complete solution, said Henk Potts, equity strategist at Barclays Wealth.
We would recommend that investors be overweight cash at least in the short term as we think it's the best safe haven at the moment. However, investors who have got a decent time horizon will be rewarded for their bravery by investing in the equity market at the moment.
Italian 10-year bond yields remained above 7 percent, even as the European Central Bank tried to stem the crisis by buying bonds. Italian bond yields are at the level reached in Greece, Portugal and Ireland when those countries needed to be bailed out.
France and Italy, the euro zone's second and third biggest economies, are considered too big to be bailed out.
Banks are reducing their risk assets by not buying new issues of maturing government bonds. Their abstinence alone drives up yields. It is not a speculation against but a lack of confidence in government bonds, said Hendrik Leber, managing partner at ACATIS Investment, which manages 1.2 billion euros.
It hurts us to see what damage the high volatility in market values is causing, given that the companies are a lot more stable than their share prices. Let's seize the opportunity to buy into quality cheaply, ACATIS said.
Political uncertainty in Europe has kept investors cautious. Governments across Europe are looking to implement austerity programmes to cut debt levels, but changes of ruling parties have played on investors' nerves.
Italian Prime Minister Mario Monti will outline austerity measures aimed at restoring confidence in Italy's strained public finances on Thursday when he goes before the Senate to seek a vote of confidence in his new government.
Mining shares came under intense pressure, tracking a sharp decline in metals price, on worries that weaker economic growth would hurt demand for raw materials.