World stocks kicked off the last quarter of 2011 lower on Monday while the yen and core government bonds rose as concerns grew over the impact a Greek default would have on Europe's banks after Athens admitted it will miss deficit targets.
A sharp fall in shares of Franco-Belgian financial group Dexia, highly exposed to Greek loans, highlighted concerns about the extent to which a default in Athens would damage already fragile European banks.
The 2012 draft budget approved by Greece's cabinet on Sunday predicted a deficit of 8.5 percent of gross domestic product (GDP) for 2011, well short of the 7.6 percent target.
Policymakers looked no nearer to agreeing on a definitive solution to the euro zone debt crisis. Officials meeting on Monday are discussing ways to leverage the bloc's rescue fund and pressure Greece to implement agreed structural reforms.
Ultimately, Greece would need to see its debt written down by more and with that you need probably some kind of shoring up of the banking sector, said Alec Letchfield, chief investment officer at HSBC Asset Management.
But the problem you would then have is to get the 17 (euro zone) governments together to agree on something. It is very difficult to do that ... Until we get a bigger and better package coming through, trading will remain volatile and often capped.
The MSCI world equity index .MIWD00000PUS fell 1.4 percent, approaching a 14-month low set in September.
European stocks .FTEU3 fell 1.8 percent with the region's banking shares .SX7P down 2.7 percent, while emerging stocks .MSCIEF lost 2.6 percent.
The October-December period is, traditionally, the best quarter for equities. Reuters data shows that since 1971 world stocks have on average risen 3.7 percent in the fourth quarter.
Dexia fell nearly 9 percent after credit agency Moody's announced a rating review for possible downgrade on concerns about liquidity. French daily Les Echos said on Friday Belgian and French finance ministers will meet on Monday to discuss ways of shoring up the firm's balance sheet.
U.S. stock futures were down around 0.3 percent, pointing to a weaker start on Wall Street later.
U.S. crude oil fell 1.2 percent to $78.24 a barrel.
Bund futures gained 61 ticks.
The dollar .DXY rose 0.4 percent against a basket of major currencies, while the yen rose 0.3 percent against the greenback to 76.87 yen and the euro gained 0.1 percent to $1.3354.
Euro zone bank issues remain a big issue and we expect the euro's downside to continue, said George Saravelos, G10 FX strategist at Deutsche Bank.
But the focus will shift to monetary policy and growth this week. There is a chance that there could be a short squeeze in the euro in the near term if the European Central Bank does not provide the support some investors are looking for.