Euro zone bank shares fell but stocks seen as resilient to an economic slowdown gained on Monday in the wake of Standard and Poor's mass downgrade of euro zone sovereign ratings, while the euro hovered near 17-month lows against the dollar.
The main euro zone bank stock index <.SX7E> fell around 0.5 percent in early trading on fears the sector could be the next target for rating cuts, while the broader FTSEurofirst 300 <.FTEU3> index of top European shares was barely changed from Friday's closing level.
The MSCI world equity index <.MIWD00000PUS> also recovered from losses seen in Asian trade to be just 0.2 percent lower. U.S. markets are closed for a holiday on Monday.
Standard & Poor's downgraded nine of the 17 countries that use the euro on Friday, with France and Austria losing their top-notch status. The rating agency also said it would decide soon whether to cut the euro zone's bailout fund from triple-A.
A one-notch downgrade for France was completely priced in, so no negative surprise here, and quite logical after the United States got downgraded, said David Thebault, head of quantitative sales trading at Global Equities.
A breakdown in Greek bailout talks added to the financial market jitters, piling pressure on Athens to complete a deal with private creditors to help it cut its debt to more sustainable levels or risk default in March, when 14.5 billion euros in repayments fall due.
The S&P move and the Greek impasse have loaded pressure on the euro zone to shore up its defenses, with the glimmers of optimism from last week now firmly doused.
The euro recovered from an early dip to be up around 0.3 percent at $1.2680, but not far away from a 17-month low of $1.2624 hit last week and well below an intraday high of $1.2879 that had been hit on Friday. Sentiment had improved last week after Madrid and Rome found investor support for their first debt sales of 2012.
I see very little upside for the euro in the coming weeks. There are still too many negatives and too many uncertainties, said Niels Christensen, currency strategist at Nordea in Copenhagen.
All the signals from S&P were that the crisis will get worse before it gets better, and I struggle to find an argument for not being short of euro/dollar at the moment.
BOND MARKET ADJUSTS
The cost of insuring Italian, Spanish and other euro zone government debt against default rose sharply on the S&P ratings cuts, while UK government bond yields fell and safe-haven German government bonds retraced gains seen on Friday after reports first emerged of the S&P action.
The European Central Bank was also reported by traders to be active in buying Italian government bonds with up to five-year maturities to keep a lid on rising yields.
Italian five-year bond yields, which had been around 6 percent in early trade, dropped to around 5.75 percent on the reports of ECB buying.
The cost of insuring five-year Italian bonds rose by 27 basis points to 531 basis points, meaning it costs 531,000 euros to protect 10 million euros of exposure to Italian debt.
German Bund futures were slightly lower at 139.77, having hit a record high of 140.23 on Friday. Ten-year cash yields were little changed at 1.782 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..
Concerns that European financial troubles will drag down global growth and sap appetite for commodities weighed on industrial metals such as copper, while gold held steady.
Brent crude rose above $111 on worries over supply disruptions after Iran warned its Gulf Arab neighbors of consequences if they raised oil output to replace Iranian barrels facing international sanctions.
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)