European shares slid on Tuesday and the euro hit a one-week dollar low point after an S&P warning of a downgrade for the eurozone overshadowed news of a Franco-German plan to save the single currency.
The surprise S&P announcement came as European Union leaders prepared for a two-day summit which is widely regarded as crucial for the future of the eurozone, whose debt crisis has sent global markets into turmoil.
In early morning deals, London's FTSE 100 index dropped 0.24 percent to 5,555.27 points, Frankfurt's DAX 30 retreated 1.14 percent to 6,036.49 points and the Paris CAC 40 dipped 0.59 percent to 3,182.74.
The euro meanwhile sank as low as $1.3334 -- hitting the lowest point since November 30 -- in the wake of the S&P news. It later pulled back to $1.3364, compared with $1.3394 late in New York on Monday.
"It was the timing of the S&P move that shocked the markets," said Kathleen Brooks, research director at trading site Forex.com.
"The EU summit is coming up on Thursday and Friday and yesterday's Franco-German summit took steps to make structural changes to the currency bloc that -- if put in place -- could alleviate the current situation and help public finances get back on the straight and narrow.
"Although the markets might like the progress, the S&P gave us all a reality check since the cure to the current problem could also be a curse -- especially for those nations with strong finances."
S&P warned late on Monday that it has placed most of the eurozone, including Germany, France and 13 other nations, on negative watch -- which means that they are at risk of being downgraded.
The shock news came just hours after German Chancellor Angela Merkel and French President Nicolas Sarkozy thrashed out strict new rules for fiscal discipline within Europe, which they hope will finally end the region's woes.
EU leaders are due to hold a critical two-day summit in Brussels from Thursday, when they will discuss the Franco-German proposals, which Merkel and Sarkozy want to be enshrined into a rewritten EU treaty.
However, Chris Scicluna, head of economic research at Daiwa, described the plan as "inadequate" and added that more comprehensive proposals were required to resolve the crisis.
"The S&P warning places the inadequate Merkel-Sarkozy initiative into context," he told AFP.
"The stricter austerity yesterday envisaged by Merkel and Sarkozy, along with the rejection of other key elements of a workable fiscal union such as common eurobonds, hardly represents the comprehensive approach to solving the financial crisis required."
And he added: "Even if policymakers pull their fingers out on Friday and announce a far more credible and powerful policy response to the crisis than that implied by yesterday's agreement between Merkel and Sarokzy, these weaker fundamentals might anyway justify a smattering of downgrades."
S&P has placed the ratings of 15 of the 17 eurozone countries on negative watch, and blamed leaders' inability to come up with a coherent plan to tackle the two-year-old sovereign debt crisis that has punished markets.
"If the response of policymakers is not viewed by investors as robust, we believe market confidence could take another, possibly steep, drop downwards" that could force the downgrade, it said in a gloomy statement.
It cited tightening credit across the single-currency zone, the rising costs for even the fiscally strongest governments to borrow, and deteriorating economic conditions that could push the whole region into recession next year.
A review of ratings would be completed "as soon as possible" following the Brussels summit.
Asian markets also fell in cautious trade on Tuesday in reaction to the news from S&P. Hong Kong slid 1.24 percent, Tokyo sank 1.39 percent and Shanghai dropped 0.31 percent.
Sydney meanwhile shed 1.48 percent after Australia's central bank cut interest rates and warned of headwinds in the global economy.
Markets in Europe -- which closed on Monday before S&P's move -- rose on the Franco-German plan while Italian bond rates fell below the 6.0 percent threshold for the first time since the end of October.
An early rally on Wall Street was pared by the ratings warning. The Dow ended up 0.65 percent, the tech-heavy Nasdaq added 1.10 percent and the broader S&P 500 added 1.03 percent.
"A glimmer of optimism returned to the markets yesterday in the aftermath of the 'Merkozy' press conference which saw Italian 10-year bond yields finish below 6.0 percent for the first time since October this year," said CMC Markets analyst Michael Hewson.
He added: "Unfortunately for Merkel and Sarkozy, they reckoned without ratings agency Standard and Poor's."