European equities retreated on Wednesday as banking stocks slipped after Moody's cut Portugal's credit rating to 'junk' and said the highly indebted country may need more bailout funds.
A 5 percent jump in the Euro STOXX 50 volatility index , one of Europe's main barometers of market sentiment, suggested a decline in investor appetite for riskier assets such as equities.
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Portugal's PSI 20 was down 2.5 percent at 0846 GMT, with volumes hitting 75 percent of its 90-day daily average, while the FTSEurofirst 300 index of top European shares was down 0.3 percent at 1,118.36.
Banks were the top losers, with the Thomson Reuters Peripheral Eurozone Banks index down 3.5 percent and the European bank sector off 1.6 percent. Portuguese bank Millennium bcp declined 5.6 percent, while Italian lender Unicredit lost 4.5 percent.
"Certainly Moody's comment over Portugal is a concern for the market. Investors are also just trying to position themselves ahead of Friday's U.S. non-farm payrolls figures," said Keith Bowman, equity analyst at Hargreaves Lansdown.
Moody's cut Portugal's credit rating at a time when concerns over Greece were easing. Moody's move reminded investors Europe's debt crisis extended beyond Greece and countries such as Ireland, Spain and Italy might also need support.
International banks and insurers were meeting on Wednesday to thrash out a plan for the private sector to contribute to Greece's bailout effort, as fears grow the proposal will be derailed.
The Thomson Reuters Peripheral Eurozone Countries Index fell 2.2 percent, Spain's IBEX was down 1.3 percent, while Italy's FTSE MIB fell 1.7 percent. Greek banks were down 2.2 percent.
Portuguese bonds led the peripheral issuers wider with yields on its two-year bonds jumping more than 1.5 percentage points to over 15 percent.
"In the longer run, the highly indebted countries of Europe will struggle to pay down their debt. This will be a long and uphill battle," said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels.
"It will not take long for the market to realise this and go once again in more defensive mood. This, together with some disappointing economic figures, will make for a volatile and nervous summer."
Investors awaited U.S. non-farm payrolls data on Friday for signals whether a slowdown in the U.S. economy was temporary. Last week's data showing U.S. manufacturing sector growth picked up in June has raised hopes of a sustained economic recovery.
"The latest data that we got from the U.S. was a bit encouraging, confirming our belief that what we have here is a soft patch and not the beginning of a severe downturn," said Klaus Wiener, chief economist at Generali Investments, which manages 300 billion euros.
"Longer term, the main theme that I see is private versus public sector assets. Given the financial strains that we have in the public sector, I would continue to expect equities to do well."