A two-day rally in European shares came to a halt on Tuesday, while the euro slipped from highs on investor caution ahead of an Italian bond auction and widespread skepticism over whether European policymakers will be able to prevent debt contagion.

Safe-haven German Bunds pushed higher after a sharp sell-off in recent days with a report that Standard & Poor's could cut France's triple-A rating outlook to negative within days bringing the focus back to how the debt crisis threatens to ensnare larger euro zone economies.

Italy, the euro zone's third-largest economy, plans to sell up to 8 billion euros of 3- and 10-year bonds later on Tuesday and is likely to pay more than 7 percent, a level that forced Greece, Ireland and Portugal to seek international aid.

The region's finance ministers are set to agree details on how to bolster the European Financial Stability Facility bailout fund in a bid to stem contagion in bond markets.

But many who are hoping for more decisive action could be disappointed as the euro zone leaders have a history of falling well short of market expectations.

The FTSEurofirst 300 <.FTEU3> index of top European shares was down 0.3 percent at 937.78 points, after rising 3.6 percent on Monday, its biggest one-day rise in a month. The STOXX Europe 600 Banking Index <.SX7P>, exposed to euro zone sovereign debt, fell 0.8 percent.

Despite all the rhetoric, I have little faith that the region's authorities are coming to terms with the scale of the problem, said Jeremy Batstone-Carr, strategist at Charles Stanley. You can talk as long as you like but we have to see the plan, and the plan has to be workable.

Tension in euro zone money market and banks' reluctance to lend to each other has also intensified. This is likely to see investors cut exposure to the euro zone and seek safer alternatives like dollar assets.

Reflecting global market strains, the Bank of Japan supplied dollars in market operations for the fourth time this month on Tuesday, providing $100 million in an operation maturing in three months and $1 million maturing in a week.

Peripheral euro zone debt came under pressure with Italian and Spanish 10-year bond spreads widening over their German counterparts. Italian 10-year yields rose 13 basis points to 7.41 percent while the cost to insure against default by Italy also edged higher.


Germany and France are reportedly working on proposals for a more rapid fiscal integration in Europe ahead of a European Union summit on December 9, but the European Central Bank has defied calls for a stepped-up role in helping resolve fiscal problems within the 17-member euro zone.

Analysts say without a more permanent wealth transfer mechanism the market is likely to be left disappointed by talk of a greater fiscal union, especially if the stance of the ECB remains unaltered. That could see the euro and riskier currencies under renewed downward pressure.

While the effectiveness of the leveraged EFSF remains questionable, we also doubt that the finance ministers will be able to pull anything materially new out of the hat tonight, said Commerzbank strategist Benjamin Schroeder.

The euro slipped from a high of $1.33734 to $1.3330 on Tuesday, trading only marginally higher on the day. It had gained more than 1 percent on Monday to a high of $1.3398.

The dollar index <.DXY> measured against six key currencies was down 0.3 percent.

(Additional reporting by Brian Gorman and Kirsten Donovan in London; Editing by)