Concerns over Spain's financial condition weighed on markets Monday, after investors had initially bid up stocks on hopes that the Federal Reserve would provide more stimulus to the U.S. economy.
Official data on Monday confirmed Spain is back in its second recession in three years after shrinking by 0.3% in the first quarter, following a similar decline in the previous three-month period.
The contraction in Spain's economy is dimming hopes that the government will be able to cut its budget deficit as predicted and raises the specter that the country might be locked into a downward financial spiral. A recession makes it more difficult to lower the deficit, and as investors lose confidence in the country, borrowing rates rise, adding to the financial pressure.
Ratings agency Standard & Poor's on Friday downgraded Spain to just three notches above junk, following up the move on Monday by lowering its rating for 11 Spanish banks.
Investors are worried that Spain will not be able to support its banks, which are burdened with massive amounts of bad loans from an imploded property market. But rescuing Spain, the fourth-largest economy in the 17-country eurozone, might prove too expensive for the continent's bailout funds.
Amid the growing uncertainty, and as traders prepared for a holiday on Tuesday across much of continental Europe, stocks dropped.
After early gains, Britain's FTSE was down 0.5% at 5,748.50 and France's CAC-40 fell 0.9% to 3,236.59. Germany's DAX lost 0.1% to 6,793.98.
The cautious mood in Europe's stock markets was also evident in the performance of the euro, which fell to $1.3232 from $1.3259 late Friday in New York.
Wall Street likewise fell: The Dow Jones industrial average was down 37 points to 13,191 shortly before noon, while the Standard & Poor's 500 index fell seven points to 1,396 and the Nasdaq composite fell 18 points to 3,051.
The Fed has already carried out two rounds of bond-buying as it tried to drive down long-term interest rates and stimulate spending and business investment. Low bond yields also encourage investors to shift money to stocks.
New statistics released Monday showed a slowdown in U.S. consumer spending growth in March, confirming that the economic recovery remains patchy.
Trading in Asia was light given holidays in Japan and mainland China. All major Asian markets except Tokyo will be closed for holidays on Tuesday.
Hong Kong's Hang Seng rose 1.7% to 21,094.21, South Korea's Kospi added 0.3% to 1,981.99 and Australia's S&P/ASX 200 gained 0.8% to 4,396.60.
Looking ahead, traders are awaiting U.S. monthly jobs figures for April, to be released Friday, and the second round of France's presidential election on Sunday.
Polls suggest the election will be won by Socialist contender Francois Hollande, who wants to renegotiate a European treaty intended to limit excessive government spending to emphasize growth over austerity. Some investors fear Hollande could upset France's delicate cooperation with Germany, which has been critical to Europe's efforts to resolve its financial crisis.
Oil prices tracked equities lower, with benchmark oil for June delivery down 76 cents to $104.17 a barrel in electronic trading on the New York Mercantile Exchange.
Pamela Sampson in Bangkok contributed to this report.