The U.S. dollar climbed to a 20-month high and safe-haven German bonds set record low yields, after data showed Europe's economic woes intensifying as business confidence is undercut by talk of a Greek exit and slow progress in tackling the debt crisis.
Private-sector factory activity in China also faltered in May as demand for exports fell, in a worrying sign the impact of the euro zone crisis could be undermining the global economic recovery. Europe is China's largest export market.
But U.S. stock index futures have edged higher as investors remain hopeful that pending data on durable goods orders and initial jobless claims will show the world's largest economy is staying on track for recovery.
The slowdown in economic activity in Europe's powerhouse Germany sent the euro down sharply against the dollar to $1.2515, its lowest level since July 2010. However, shares staged a modest rebound after sharp falls on Wednesday and commodity prices mostly gained.
The key reading from the latest round of Markit Purchasing Managers Indexes (PMIs) was a fall in Germany's factory sector, which was hit by a drop both in exports and new orders for goods.
In addition, German business sentiment dropped for the first time in seven months, missing even the most conservative forecasts, according to the Munich-based Ifo think tank.
"Companies are now reacting to the increased uncertainty out there. And that's not going to abate," Andreas Scheuerle, an economist at DekaBank, said.
The PMI data for the whole euro area showed activity was declining at a faster pace than expected in May, which was seen as confirmation that a downturn started in smaller periphery members is taking root in the core countries of Germany and France, whose tepid growth had been keeping the troubled bloc afloat.
"It's a message to EU policymakers that the situation is not as good as they describe it," Lloyds Bank strategist Achilleas Georgolopoulos said.
EUROPE DOMINATES
The data added to widespread nervousness about the impact on the region's fragile banking system if Greece leaves the euro zone, and growing signs of a lack of cohesion among EU leaders on how to tackle the debt crisis.
A summit of European Union leaders, who have been advised by senior officials to prepare contingency plans in case Greece decides to quit the single currency, was unable to shed new light on what euro zone nations plan to do.
As a result, 10-year German government bond yields fell to a record low of 1.35 percent and 30-year bond yields were 8.8 basis points lower at 1.91 percent, a new all-time low.
The yield on 10-year UK government Gilts was down 2 basis points at 1.749 percent, having fallen to a record low of 1.74 percent.
The UK reported its own recession was deeper than originally thought, with the economy contracting by 0.3 percent in the first quarter of this year, causing the first annual decline in output since the final quarter of 2009.
Britain is in its second recession since the 2007-2008 financial crisis and pressure is building on the central bank to consider more quantitative easing (QE).
"The downward revision to UK Q1 GDP, … the downward trend in UK CPI inflation, worrying German survey data and strengthening headwinds from the euro zone all suggest the case for more QE from the BoE (Bank of England) is mounting," Jane Foley, senior currency strategist at Rabobank, said.
European shares, which on Wednesday recorded one of their biggest daily declines of the year, staged a modest recovery despite the signs that factory activity was deteriorating in major economies.
The FTSEurofirst 300 index of top European shares was up 1.2 percent at 983.81, after slipping 2.2 percent in choppy trade on Wednesday.
MSCI's world equity index added 0.3 percent, lifted by slight gains in emerging markets, recovering from 2012 lows posted in the previous session.
Oil markets initially eased on the Chinese PMI data.
HSBC's Flash Purchasing Managers Index, the earliest indicator of China's industrial sector, retreated to 48.7 in May from 49.3 in April, marking the seventh straight month that the index has been below 50, indicating contracting economic activity.
But reports of a hiccup in talks with Iran over its disputed nuclear programme turned the markets around with Brent crude oil gaining 74 cents to $106.30 a barrel, and U.S. crude rising $1.03 cents to $90.93.
