The euro retreated from a three-week high on Tuesday and Asian shares gave up most of their early gains as crucial negotiations on Greek debt restructuring suffered another major setback, raising the specter of default.
Financial spreadbetters expected Britain's FTSE 100 <.FTSE>,
Germany's DAX <.GDAXI> and France's CAC-40 <.FCHI> to open down around 0.4-0.6 percent.
The MSCI's broadest index of Asia-Pacific shares outside Japan rose as much as 0.2 percent to a 10-week high before easing to stand barely changed, as Australian shares pared earlier gains to end flat on concerns about Europe.
The pan-Asia index, on the other hand, drew some support from Indian shares <.BSESN>, which extended gains after the Reserve Bank of India cut the cash reserve ratio for banks, underscoring a policy shift from fighting inflation to reviving growth.
Japan's Nikkei average <.N225> ended up 0.2 percent at its highest closing level in nearly three months on hopes that a Greek debt deal may still be salvaged. <.T>
Activity was thin, however, with many Asian markets still closed for the Lunar New Year holiday.
U.S. stock futures slipped 0.3 percent as investors awaited earnings reports from bellwethers such as Apple
Euro zone finance ministers on Monday rejected an offer made by private bondholders to help restructure Greece's debts, sending negotiators back to the drawing board.
The ministers also discussed efforts to enforce stricter budget rules for European Union states and steps to finalize the structure of a permanent euro zone bailout fund.
The fund is a key safety net to contain the euro zone debt crisis and Germany is playing a major role. Germany denied a report on Monday that it was ready to boost the combined firepower of the euro zone's rescue funds to 750 billion euros.
The outcome of PSI (Greek debt) discussions, good or bad, can hardly surprise market participants at this stage, said analysts at Barclays Capital in a research note.
However, stretched sentiment suggests that the risk asset rally (of recent weeks) may be losing steam and is temporarily vulnerable, they said.
Senior Europe financials CDS: http://link.reuters.com/xer26s
Euro zone debt crisis in graphics (package) http://r.reuters.com/hyb65p
BOJ, Fed balance sheets http://link.reuters.com/nyt65s
EURO LOSES STEAM
The setback in the Greek debt talks pushed the euro off a three-week peak around $1.3050 hit on Monday.
The single currency slipped to a session low below $1.2990 after a report raised fears that Portugal, another euro zone member as highly vulnerable as Greece, could potentially face default.
The euro last stood at $1.3009, well above a 17-month trough near $1.2624 plumbed on January 13, but sentiment may be further dented later in the day with the release of Markit's flash Eurozone Composite Purchasing Managers' Index (PMI), a measure of the euro zone company activity.
The reports are expected to reflect deteriorating growth. A Reuters poll last week showed most economists believed the euro zone would wallow in a mild recession until the second half of this year, assuming the region's debt crisis does not flare out of control.
Risks posed by Europe's debt woes prompted the Bank of Japan to cut its growth forecasts on Tuesday.
While the debt crisis festers, sentiment has improved with positive effects from the lifelines extended to the European financial system by the European Central Bank via its generous funding to ease funding strains partly overshadowing worries over an individual country's borrowing ability.
Ten-year Italian government bond yields fell 10 basis points at 6.17 percent on Monday, as European banks used ECB funding to buy more Spanish and Italian bonds. The yield was sharply off this month's high of 7.2 percent.
Receding concerns over Europe sapped safe-haven appetite for U.S. Treasuries, and the rise in Treasury yields pulled 10-year Japanese government cash bond yield up to above 1 percent on Tuesday, its highest since mid-December.
Reflecting stabilizing market sentiment and receding fears of sharp market falls, the CBOE Volatility index VIX <.VIX>, which measures expected volatility in the S&P 500 over the next 30 days, was nearing a 2011 low of 14.30.
The VIX closed at 18.67 on Monday. Major 2011 lows around 14.30-15.25 have caused sizable rallies, so a move towards these support levels could open the way for a continuation of the risk rally.
Oil prices held steady after gaining on Monday as EU foreign ministers agreed to ban imports of Iranian oil from the start of July to pressure Iran over its nuclear ambitions, a move that renewed threats by Teheran to block a vital oil export route.
(Additional reporting by Reuters FX analyst Krishna Kumar; Editing by Kim Coghill)