World stocks hit a three-week low Thursday and the euro tumbled across the board while top-rated government bonds rallied as fears of a breakup of the euro zone gathered pace ahead of a key debt sale in Italy.
Italy, which has for now replaced Greece as the biggest source of investor concern, will offer up to 5 billion euros of short-term Treasury bills, maturing in November 2012, in a key test of Rome's ability to fund itself.
The two-year-old euro zone debt crisis has spurred fears of a split in the euro zone, which can't afford to bail out Italy.
EU officials told Reuters that French and German officials had held talks on splitting the zone.
The T-bill auction will be a big test of sentiment given the way Italian paper traded yesterday, a eurozone bond trader said.
I'm expecting more of the same today in terms of sentiment, especially after the reports overnight of a smaller euro zone being discussed by France and Germany.
Poor corporate results from the financial and industrial sectors also weighed. Third-quarter net profit of France's third-biggest listed bank, Credit Agricole, slumped by 65 percent on the back of Greek sovereign debt losses.
Germany's Siemens, a bellwether for the eurozone's largest economy, proposed a smaller-than-expected 11 percent increase in its full-year dividend after its quarterly operating profit fell short of expectations.
The MSCI world equity index fell 1.25 percent to hit its lowest since Oct. 21. The index is down nearly 10 percent since January.
European stocks fell 1.2 percent while emerging stocks <.MSCIEF> lost more than 3 percent.
Brent crude oil dropped half a percent to $111.83 a barrel. Bund futures gained 23 ticks.
The premium investors pay to hold Italian debt over top-rated German 10-year government bonds widened 13 basis points to 565 bps. French/German 10-year government bond yield spread widened 13 basis points to a euro-area high of 161 bps.
The yield on 10-year Japanese government bonds fell to a one-year low of 0.960 percent, supported by worries over the euro zone's debt crisis.
The dollar <.DXY> rose 0.1 percent against a basket of major currencies.
The euro lost a quarter percent to $1.3515, hitting a one-month low around $1.3480 earlier.
We think the fair value for the euro is at $1.35-1.36 and think these levels will be sticky given how heavy positioning is against the euro, said Ankita Dudani, G10 currency strategist at RBS Global Banking.
We are bearish on the euro zone, but we do see steady support for the euro from the Middle East and Asian sovereign investors.
The single currency suffered its sharpest daily fall in 15 months on Wednesday after yields on 10-year Italian bonds spiked above 7 percent, a level where the cost of financing a debt burden of more than 2 trillion euros is seen as unsustainable.
(Additional reporting by Kirsten Donovan and Anirban Nag; Editing By Toby Chopra)