Concerns over euro zone sovereign debt and the region's banks sent the single currency and stocks lower on Thursday although the first French bond auction of 2012 helped dispel some fears about the ability of governments to fund their massive debts.
Yields rose at the auction of 10- to 30-year French government bonds as the threat of a cut to France's triple-A credit rating weighed on sentiment, but solid demand was seen with the 7.96 billion euro sale nearly twice oversubscribed.
Fears that European banks will struggle to raise fresh capital to repair their ravaged balance sheets rose after Italy's largest bank, UniCredit, had to heavily discount a rights issue to sell the shares on Wednesday.
The French auction was viewed as a key test of market sentiment following the unveiling by European Union leaders in December of a plan to resolve the debt crisis and the move by the European Central Bank to pump nearly half-a-trillion euros into the region's troubled banks.
Markets have also been bracing for France to lose its top-notch rating after ratings agency Standard & Poor's warned in early December of a mass downgrade of euro zone states due to concerns about the bloc's two-year old debt crisis.
"It's (the auction result) nothing to get excited about. But, at the same time it should be enough to dispel concerns with regards to France's funding capacity for the time being," said Michael Leister, a strategist at DZ Bank in Frankfurt.
As with Germany's bond auction on Wednesday, the French debt sale was seen as reasonably successful but not impressive.
A sterner test of investor sentiment is expected next week, when Spain and Italy, the two big economies seen as most at risk from the crisis that has already dragged down Greece, Ireland and Portugal, are due to issue bonds.
The euro was down 0.75 percent to around $1.2840 after the auction, below the September 2010's low of $1.2847.
The FTSEurofirst 300 index of top European shares, which had fallen ahead of the French bond auction, slid further and was down 0.8 percent at 1013.49 points. It hit a five-month high on Tuesday but fell 0.6 percent in the previous session.
The European banking sector was the main drag on stocks, with the STOXX Europe 600 Banks index down more than 2 percent on the worries about prospects for more capital raising.
The MSCI world equity index edged down 0.5 percent building on losses seen earlier in Asian stock markets.
The difference between Spanish and Italian government bond yields and safe-haven German Bunds also widened.
In the secondary debt market, 10-year French government bonds reversed earlier losses ahead of the auction to be little changed at a yield of about 3.3 percent.
HUNGARIAN PROBLEMS LOOM
Elsewhere in European Union attention was focused on the selloff in Hungarian financial markets, which is forcing investors to weigh the possibility of a default in the European Union state and the risk of contagion to other regional economies.
Hungary needs to find around $16.5 billion this year to repay debt owed to bondholders and the International Monetary Fund, but is effectively cut off from global capital markets as growing mistrust in its policies pushes up borrowing costs.
In commodity markets Brent crude moved back under $114 barrel having earlier risen on fears of supply disruption after the United States and European Union stepped up pressure on Iran agreeing in principle to ban oil imports from the No. 2 OPEC producer.
Brent crude was down about 0.12 percent $113.58, after advancing nearly 6 percent in the past two sessions to close at the highest since Nov. 11 on Wednesday.