European shares paused early on Monday as Italy's credit rating downgrade hit domestic banks, taking the shine off an equity rally which remains supported by unprecedented stimulus from governments and central banks.
By 0858 GMT, the FTSEurofirst 300 was down 2.35 points, or 0.2 percent, at 1,192.85. It had closed at 1,195.20 on Friday, a level not seen since September 2008, boosted by strong U.S. jobs data. Support for the financial system from global central banks also continues to buoy asset prices.
Italy's benchmark FTSEMIB was the main weight on Europe, down 0.9 percent, and eight of the top nine fallers in the European banking sector, which also fell 0.9 percent, were Italian banks.
Pressure on them to increase provisions against bad debt could grow after Fitch cut the country's credit rating by one notch to BBB-plus with a negative outlook, citing political uncertainty following last month's inconclusive election.
"I think the downgrade has caused a ripple in the Italian market, which has been very calm since the election two weeks ago," said Heinz-Gerd Sonnenschein, equity markets strategist at Deutsche Postbank.
Spreads on weaker euro zone countries' bonds widened in the wake of the Italian downgrade late on Friday.
Deutsche Postbank's Sonnenschein said the impact could be short-lived, reflecting the European Central Bank's pledge to step in if asked. He saw Italian financial stocks as too risky an asset class to invest in at this stage, however, as political uncertainty clouds the country's economic outlook.
Italy's FTSEMIB, which is heavily weighted towards financial stocks, is down 0.4 percent year-to-date, underperforming indexes of struggling southern European peers such as Spain , whose IBEX is up 5.6 percent in 2013.
Goldman Sachs cut its estimates across the board for Italian banks as non-performing loans continue to rise and coverage ratios keep dropping, noting that the pressure to make provisions for bad loans is mounting.
Citigroup, meanwhile, said it expects the Italian banks it covers to report fourth quarter losses, due mostly to a high level of provisions.
The pressure to increase reserves also weighed on Norway's top bank DNB, which fell 2.9 percent after the country's financial regulator said insurers need to build up more reserves to reflect increasing life expectancy. It said they would need some 50 billion crowns ($8.72 billion) more than previously forecast.
DNB said the new calculations indicated its insurance arm required 14.4 billion crowns in additional reserves, of which 3.8 billion crowns had already been set aside.
European insurers were down 0.3 percent as the cut in Italy's debt rating dragged.
Top individual fallers in Europe were hit by broker downgrades with accountancy software provider Sage falling 4.1 percent after BofA Merrill Lynch cut its rating to "underperform". It cited concerns over Sage's valuation and the slow process in its cloud solutions gaining traction.
Dutch telecom company KPN shed 2.6 percent as Nomura cut its rating to "reduce" from "neutral" saying it saw significant downside in the shares going into a rights issue.
Among standout gainers was Italian carmaker Fiat, which climbed 2.7 percent after Deutsche Bank raised its recommendation to "buy" from "hold" saying the firm's shares have been "overlooked and undervalued"
