European shares fell on Tuesday, ending a week-long rally, after ratings agency Standard & Poor's warned it might downgrade top-rated Germany and other euro zone countries if leaders fail to agree how to solve the region's debt crisis.
Banks, a focus of the crisis due to their exposure to sovereign debt, were among the main fallers, with the STOXX Europe 600 Banks index <.SX7P> down 1.1 percent after rising 18.2 percent in the last week on hopes Germany and France were formulating a solution.
Investor sentiment was hit after S&P said that political as well as financial solutions needed to be found, halting a one-week rally in shares.
S&P placed the ratings of 15 euro zone countries on credit watch negative, including the region's two biggest economies Germany and France, and said systemic stresses are building as credit conditions tighten in the 17-nation region.
S&P is just reminding everyone the problems are still there in the euro zone and it is going to have a real impact on these countries, Joe Rundle, head of trading at ETX Capital, said.
It is a reality check, but I do not think all the gains from last week will be given up as the market could think it will push the euro zone into action.
By 9:57 a.m., the pan-European FTSEurofirst 300 <.FTEU3> index of top shares was down 0.3 percent at 990.48 points after gaining 10.4 percent in the past week and hitting a five-week high on Monday.
On Monday, French president Nicolas Sarkozy and German chancellor Angela Merkel agreed on a plan which would impose budget discipline across the euro zone. The plan is to presented to other member states at a summit on Friday.
Traders said the FTSEurofirst would find support at 983.38 points, its 50 percent Fibonacci Retracement from its July to September sell-off, while resistance would be met at 1,014.14 - its 61.8 percent Fibonacci Retracement level from the sell-off.
The drugmaking sector featured amongst the top performers as investors moved out of the cyclical sectors into defensives, with the STOXX Europe 600 Health Care index <.SXDP> up 0.7 percent.
The S&P move heightens how important the EU summit is and highlights the consequences if there is no agreement by policymakers at it, said Joshua Raymond, Chief Market Strategist, City Index.
Investors are on edge, we are seeing some diversification away from the riskier sectors to the more defensive like drugmakers.
The utility sector traditionally also seen as defensive, however, was also amongst the heaviest fallers, and was a reminder that safe-haven stocks are not always immune in a downturn.
The worst performer on the FTSEurofirst was RWE
We would stay sidelined, Sebastian Zank, analyst at Silvia Quandt Research, said. Investors would not like the idea of the significant dilution and the uncertain outlook on the company's dividend payments in 2013, he added.
(Reporting by Joanne Frearson; Editing by Erica Billingham)