European stocks closed sharply lower Tuesday after a report showed a contraction in the U.S. services sector in January, increasing fears of a recession in the world's biggest economy.
The Institute for Supply Management's non-manufacturing index fell to 41.9 last month, to its lowest value since October 2001, from 54.4 in December and compared with market expectations of 52.5.
An increasingly gloomy picture of the global banking sector also sent European shares lower, after JP Morgan cut its price target for numerous European banks including Credit Suisse, UBS and Deutsche Bank.
Stocks had been weak throughout the morning session following brokerage downgrads for U.S. credit card firms and banks on signs that consumers are not keeping up with their debt payments.
Analysts said evidence that the credit crunch was spreading to other areas of the economy, rather than fears of a recession in the U.S., may have prompted the Federal Reserve to cut rates aggressively over the past months.
"The sharp swings on shares of financial institutions is a sign that uncertainty is still really high. People use every bit of news to buy or sell. But the subprime crisis is far from over and I don't see how the market could rally," said Jean-Francois Virolle, chief strategist at Global Equities.
"People are waiting to see what the Bank of England and the European Central Bank will do and say later this week."
But the losses were cushioned by the energy sector. BP reported a drop in fourth-quarter net profit, as weakening margins and one-off charges outweighed the advantage of higher oil prices, but also said it would boost its dividend. Shares of BP ended 0.2 percent higher.
In other earnings news, Dutch telecommunications company KPN reported fourth-quarter core earnings in line with market expectations, but announced it would cut more jobs as the recent acquisition of Getronics boosts revenues at the telecom company.
Corporate Express of the Netherlands is reportedly in early-stage talks to be bought by U.S. rival Staples, according to Dutch newspaper De Telegraaf. Shares finished 15.7 percent higher.
In Germany, MAN's shares fell 8.2 percent despite the company reporting 83-percent increase in fourth-quarter earnings, due to strong demand in its truck business.
And the race for Northern Rock is now down to two remaining bidders – Richard Branson's Virgin Group and the in-house management – after investment firm Olivant pulled out late Monday. Shares of Northern Rock were 2.3 percent higher.
Weak PMI in Europe
Weak data also dampened the mood in Europe. Euro zone services sector growth slowed much more than expected to a four-and-a-half year low in January although growth in prices charged barely slipped, a key survey showed on Tuesday.
Spain's service sector shrank at its sharpest ever rate as evidence grew that the economy is slowing more than anticipated.
"The sky is tumbling in on the Spanish services sector," Bear Stearns analysts wrote in a note.
"If the ECB are listening to problems in Southern Europe they should be racing to the tape to cut rates. With Italy heading for recession this year, Spain's economy in trouble and growth prospects slowing sharply in Portugal, the ECB should be tipping the policy pendulum to easier rates a lot sooner than expected," they wrote.
-- Reuters contributed to this report