European shares and the euro gradually recovered on Monday from early losses triggered by the mass downgrade of euro zone sovereign ratings last week, but they still looked vulnerable amid rising fears of a disorderly Greek debt default.
Markets had already reacted to the downgrades on Friday, and European assets steadied by Monday afternoon, but activity was limited with U.S. markets closed and the problems in the region's debt markets continued to weigh on sentiment.
The European Central Bank more than tripled its bond purchases in the week to January 13 to calm market fears and halt the rise in yields, spending 3.77 billion euros compared with 1.1 billion the previous week, data showed on Monday.
However, the glimmer of hope which had emerged after solid bond auctions by Italy and Spain last week, and a view that the S&P move on ratings had been well telegraphed, helped steady market nerves though confidence could quickly ebb.
If we were to see the start of a downward spiral, and any further loss of confidence in the euro zone started to materialize, that would have a broader negative impact for the euro and riskier currencies in general, said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
The euro was up 0.3 percent against the dollar at $1.2673 in late European trade in thin trading but was still seen vulnerable to a test of Friday's 17-month low of $1.2624.
The FTSEurofirst 300 <.FTEU3> index of top European shares ended up about 0.8 percent at 1,025.64 points in low volume while the main euro zone bank stock index <.SX7E> reversed some heavy early losses on fears the sector could be the next target for rating cuts to end up 0.3 percent.
World shares overall <.MIWD00000PUS> recovered from losses seen in Asian trade to be just 0.1 percent higher.
DEBT FEARS REMAIN
Growing nervousness saw Europe's commercial banks park almost half a trillion euros at the European Central Bank, the highest on record, as the mix of debt crisis worries and a recent giant injection of ECB cash left banks awash with money but too scared to lend it.
Market attention was likely to switch on Tuesday to the state of the euro zone's economy with the latest ZEW survey on the health of the giant German economy due.
Germany's economy contracted by about 0.25 percent in the fourth quarter as growth slowed in the second half of last year, according to an estimate by the statistics office.
Berlin will cut its forecast for 2012 economic growth to just 0.75 percent yet expects the jobless rate to decline further to 6.8 percent on an annual basis a German newspaper, Ruhr Nachrichten, reported on Monday.
Investors also await Chinese GDP data to gauge the outlook for growth in the world's second-largest economy with forecasts calling for a fourth successive quarterly slowdown in growth to around 8.7 percent from 9.1 percent previously.
Debt markets are focused on Greece with senior officials from the government due in Washington for meetings with the International Monetary Fund to try to break a deadlock in debt swap talks that has prompted the fears of an unruly default.
The cost of insuring Italian, Spanish and other euro zone government debt against default rose on the S&P ratings cuts, while shorter-dated UK government bond yields fell. Safe-haven German government bonds retraced gains seen on Friday after reports first emerged of the S&P action.
The ECB was also reported by traders to be active in buying Italian government bonds to keep a lid on rising yields.
Italian five-year bond yields, which had been around 6 percent in early trade, dropped to around 5.77 percent on the reports of ECB buying.
The cost of insuring five-year Italian bonds rose to around 515 basis points from under 500 basis points on Friday, meaning it costs 515,000 euros to protect 10 million euros of exposure to Italian debt.
German Bund futures were slightly lower at 139.91, having hit a record high of 140.23 on Friday. Ten-year cash yields were little changed at 1.772 percent.
Italy takes a break from debt sales this week, but France plans to sell up to 8 billion euros of debt on Thursday and Spain comes to the market with sales of 2016, 2019 and 2022 bonds..
Yields on French treasury bills eased marginally on Monday in the first test of investor appetite for the country's debt since it was stripped of its coveted triple-A credit rating on Friday.
Concerns that European financial troubles will drag down global growth and sap appetite for commodities weighed on industrial metals such as copper, while spot gold held steady at around $1,645 an ounce.
However, oil futures rose on Monday on growing tension between Saudi Arabia and Iran, after the Islamic state told its Gulf Arab neighbors not to make up any shortfall caused by an embargo on its crude oil exports.
The latest threat comes as leaders of top Asian buyers of Iranian oil - China, Japan and South Korea - tour alternative Middle East suppliers while the United States pressures nations to stop importing oil from the Islamic Republic.
Euro-zone sovereign ratings: http://r.reuters.com/maf75s
Regional equity risk premium:http://link.reuters.com/mum95s
(Additional reporting by Jessica Mortimer and Blaise Robinson; Editing by Catherine Evans/Patrick Graham/Susan Fenton)