Stock rally runs out of steam on EU plan doubts

The euro dropped 0.5 percent and world stocks 0.7 percent after leaping in the previous session, while Chinese equities slipped 2 percent to their lowest in a year, hit by mounting concerns over a worsening inflation outlook.

Wall Street was also poised to trim Monday's stellar gains, with U.S. stock index futures signaling a lower open.

Yesterday we saw short covering following the Ecofin meeting at the weekend but we are back to reality now, said Jeremy Batstone-Carr, head of research at Charles Stanley.

I've seen the gains described as a 'sucker's rally', and I tend to agree, there are just too many uncertainties out there for a lasting recovery.

After Monday's euphoria during which the STOXX Europe 600 banking index <.SX7P> jumped nearly 15 percent, investors turned cautious again, concerned that the massive plan was not a long-term solution to the euro zone's sovereign debt problems.

In a sobering note, the International Monetary Fund said that even though Greece's public debt was sustainable over the medium term, the nation faced plenty of risks.

Moody's credit ratings agency also warned it might downgrade Portugal's debt rating and further cut Greece's to junk status, noting the contagion effect of Greece's crisis on other euro zone members.

Contagion has spread from Greece -- historically a weaker credit in the context of the euro zone -- to sovereigns with stronger credit metrics like Portugal, Ireland and Spain, Moody's said.

TIGHTENING WORRIES IN CHINA

Investors were also digesting data showing Chinese inflation inched up to an 18-month high in April and bank lending topped expectations, although the full suite of monthly data signaled an economy that is not overheating as some have feared.

Chinese inflation was stronger than expected and there are worries they might put up interest rates, said Bernard McAlinden, investment strategist at NCB Stockbrokers in Dublin.

Oil fell to just below $76 a barrel, while base metal prices also lost ground. Gold prices rose in Europe, helped by the return of concerns over the euro zone's fiscal health.

Core euro zone government bond prices climbed, tracking gains in U.S. Treasuries.

The June Bund future was up 29 ticks on the day at 125.78. The 10-year Bund yield was down 3.1 bps at 2.918 percent while the two-year Schatz yield was down 1.7 basis points at 0.592 percent.

Traders said they were anxious to see whether peripheral sovereign debt yield spreads would widen, reversing some of the price action the previous day, after European Central Bank Governing Council member Axel Weber said late on Monday that bond-buying by euro zone central banks would be limited in scope.

(Additional reporting by Simon Falush and Brian Gorman in London; editing by Jason Webb)