A jump in Italy's borrowing costs, reflecting growing concern about a revival of the euro zone debt crisis, put European shares and the single currency under pressure on Thursday.
Italian three-year bond yields jumped to 3.89 percent at a bond auction, a rise of more than one percentage point compared with a month ago, as budget troubles in Spain and concerns over global growth prompted investors to demand a higher return to buy Italy's paper.
"Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently," said Nick Stamenkovic, strategist at RIA Capital Markets in Edinburgh.
Italian officials have pointed the finger of blame at Spain, whose borrowing costs have soared since Prime Minister Mariano Rajoy ripped up a 2012 budget deficit target agreed with Brussels.
Rajoy hit back on Wednesday, telling European leaders to be more careful when they talk about Spain as it struggles to show markets it can control its finances.
Italy's sale of March 2015 bonds on Thursday drew bids worth 1.4 times the 2.88 billion euros offered and the bonds sold at a yield of 3.89 percent compared with 2.76 percent at the last such sale in mid-March.
After the auction the euro retreated from near a one-week high of $1.3158 struck on Wednesday, to be largely unchanged at $1.3125 and well within the $1.3030-$1.3165 range trodden in the past week.
European equity markets edged lower, reversing earlier gains and pausing the previous session's tentative recovery.
Yields on 10-year Italian bonds were down six basis points to 5.47 percent on the day, little moved by the bond tender results. Spanish 10-year bond yield were 1.4 basis points lower at 5.88 percent, though here the Italian auction did push the yields off earlier lows.
Stamenkovic said the result also showed the impact of a trillion euro-plus injection of liquidity into the region's banking system by the European Central Bank through two long-term refinancing operations was beginning to dissipate, having boosted shares and sliced Italian and Spanish bond yields in the first quarter.
The turmoil in Spain's bond market, that saw 10-year yields touch around six percent on Tuesday, has calmed a little since ECB executive board member Benoit Coeure hinted the central bank might be willing to buy more government bonds. But hardliners within the ECB are strongly opposed to reviving that programme.
German Bund futures, generally viewed as a safe haven in times of trouble, extended their gains after the sale to be up as much as 19 ticks to 140.01, with 10-year cash yields steady at a near-record low 1.69 percent.
STOCKS RECOVERY ENDS
The FTSEurofirst 300 index of top European shares rose was down 0.15 percent, at 1,032.40. The Euro STOXX 50 index of Europe's blue chip companies was down 0.6 percent to 2,326.28, having suffered a 4.5 percent decline over the last five days that all but eradicated year-to-date gains.
The MSCI world equity index was up 0.15 percent 322.65 after a good start to the U.S. corporate reporting season lifted Wall Street stocks and a strong Australian employment report encouraged the rebound in Asia.
The dollar was slightly softer against a basket of currencies following comments by the No. 2 official at the U.S. central bank, Janet Yellen, who said the Federal Reserve's ultra-easy monetary policy was appropriate, given high unemployment and the headwinds facing the economy.
Oil markets were all mostly steady, supported by the weaker dollar and hopes of faster world economic growth.
Brent crude was up 10 cents at $120.28 a barrel after touching a low of $119.93 in early trade. U.S. oil was up 30 cents at $103, adding to $1.68 a barrel gains made on Wednesday.
The International Energy Agency, which advises 28 industrialised nations on energy policy, said in its monthly report the oil market could be turning the corner after more than two years of tightening as global oil inventories rose.