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Inflation, Credit Worries Dent Europe Stocks

A bout of risk aversion dented European stocks on Tuesday as jitters grew over potential credit-related problems at banks and inflation, while typically defensive stocks such as pharmaceuticals and food rallied.

A drop in the price of crude oil futures to below $130 a barrel in line with a rise in the dollar helped the European market pare some of its losses in afternoon trade, but weighed on the energy sector, making BP and Total the largest drags, falling 1.7 to 2.1 percent.

The FTSEurofirst 300 index of top European shares fell 0.4 percent to 1,314.42 points, having earlier hit its lowest in a month.

Nestle was the top weighted gainer, rising nearly 1 percent, followed by Swiss drugmakers Roche and Novartis, which rose 1.9 and 1.6 percent, respectively.

Concern about inflation, fuelled by the 15 percent rise in the oil price this month, has stripped the FTSEurofirst of all of May's gains.

"People are just increasingly concerned about the inflation risk picking up and the U.S. economy deteriorating,'' said Andrea Williams, head of European equities at Royal London Asset Management. "(Today is) just a rotation really. You have to question the ability of some of those companies to pass on higher input costs and inflation. It's very difficult. You have to focus on companies you feel have the ability to do that and there is an ever-smaller list.''

European Central Bank Governing Council member Axel Weber told Reuters in an interview in light of stubbornly high inflation and robust growth, the ECB had no scope to cut euro zone rates this year and the option of a rate rise must remain on the table.

The V-DAX index, a measure of underlying volatility of options on Germany's blue-chip DAX index, hit its highest level in a month at one point on Tuesday, while euro options volatilities jumped by as much as 40 basis points, reflecting investor nervousness.

The pan-European stock index has lost 1.3 percent this month after a gain of 6 percent in April, driven down by concern over inflation and funding issues at banks, the sector worst hit by frozen credit markets.

More Bank Worries

Switzerland's UBS, one of the worst European casualties of the credit crisis, fell 0.3 percent as it started trading ex-rights and as worries over its potential exposure to more writedowns persisted.

On Monday, the bank said in its prospectus for a rights issue it still held positions linked to the U.S. residential mortgage market and may incur additional losses due to such exposure.

Societe Generale fell 0.4 percent, Deutsche Postbank 1.4 percent and Royal Bank of Scotland 2.2 percent.

"The stress factors on financial stocks are still there, such as falling house prices and fears that the credit crisis is moving to other underlyings from mortgage-backed securities, and affecting more classical ways of lending,'' said Gerhard Schwarz, head of global equity strategy at UniCredit in Munich. "There's a risk that defaults will rise this year.''

The latest European Central Bank figures showed that a bank or banks borrowed 538 million euros from the bank on Monday, which rekindled fears about the health of the financial system.

"The ECB lending shows that money markets are still not functioning and the preferred way of sourcing funds is still from the central bank. The spreads on Euribor are very high compared to refinance rates,'' said Schwarz.

Other decliners included mining stocks, which encountered a bout of profit-taking after rallying by as much as 15 percent in May. Rio Tinto fell 1.9 percent, while BHP Billiton lost 1.9 percent and Xstrata fell 1.2 percent.

Britain's FTSE fell 0.5 percent, while France's CAC fell 0.6 percent and Germany's DAX was flat.

Among gainers, British brewer SABMiller rose nearly 7 percent after the Financial Times said Belgian brewer Inbev was weighing moves to consolidate its share of the global beer market and had designs on SABMiller or Anheuser Busch. Inbev fell 1.9 percent, while Anheuser Busch traded flat on the New York Stock Exchange.

Among other movers, Vodafone fell 1.7 percent to reverse earlier gains after the Gulf state's telecom regulator said that a unit of the British company had agreed to pay 7.72 billion riyals ($2.12 billion) for Qatar's second mobile phone licence.

Vodafone shares rose earlier in the day after it met expectations with its outlook for 2009 and full-year earnings, and said its chief executive Arun Sarin was to leave. GlaxoSmithKline fell 1.5 percent after a Morgan Stanley downgrade.