Major stock indices fell by more than 1.5%, led by France's CAC 40 -- down 1.9% after activity in the country's services sector fell to its lowest level in four years, according to the Purchasing Managers' Index (PMI) for February. The prospect of a prolonged recession in the eurozone also pushed the euro to six-weeks lows against the dollar.
Investors began Thursday's session in a cautious mood after the publication Wednesday of minutes from the Federal Reserve revived talk of an end to the bank's bond-buying program.
With the exception of the FTSE 100, the declines all but wiped out year-to-date gains on major European indices, including the CAC 40 and Germany's DAX. But stock markets are still trading near highs last seen in 2007, and the euro remains 6% up against the dollar over the past six months.
"The temptation to book some profits was running high even before the start of today's European session with investors also fretting about the upcoming Italian elections and US spending sequesters," noted ETX Capital market strategist Ishaq Siddiqi, referring to looming automatic spending cuts in the U.S.
Italy's leading shares slumped 2.6%. The MIB index has fallen 10% since late January as a surge in opinion polls by former Prime Minister Silvio Berlusconi raised the chances of a return to political instability in the eurozone's most heavily-indebted major economy.
Polling is banned in the immediate run up to the Italian election this weekend, leaving investors in the dark about the latest position of the major parties.
"The fact that markets still have no real indication on who is gaining in the polls in Italy with the election just days away [means] traders are hesitant to hold onto positions or switch on the bull signal and would rather unwind positions," ETX's Siddiqi added.
The eurozone PMI survey for February was much weaker than economists were expecting, and suggests that the recession that began in April 2012 will continue at least until the end of March. The February data is consistent with a fall of 0.3% in eurozone gross domestic product in the first quarter of 2013.
And with inflation falling fast, the disappointing data may increase pressure on the European Central Bank to cut interest rates from their current record low of 0.75% or consider other ways of injecting fresh stimulus into the 17-nation eurozone economy.
"We think the PMI data by themselves will increase pressure on the ECB to cut interest rates again, though at this stage we doubt rates will be cut as early as March," noted economists at investment bank Nomura.
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