Europe stress test rally fades after Ifo disappoints

Europe's stock markets closed lower after a closely-watched German economic report came in weaker than expected, putting the brakes on a relief rally over the results of a key health check on the region's banks.

The pan-European FTSEurofirst 300 closed provisionally down 0.5 percent. A report by the influential Ifo think tank showed German business sentiment darkened in October, hitting its lowest level in almost two years.

"German business confidence dropped for the sixth month in a row in October, illustrating the euro zone's biggest economy has reached a dangerous stage between soft spell and longer-lasting almost-stagnation," Carsten Brzeski, chief economist at ING-DiBa said.

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The broader banking sector, which was up in opening trade, retreated after the data.

Monte dei Paschi di Siena, which has the biggest capital shortfall and will need to raise a further 2.1 billion euros, came under pressure. The stock ended the day down 15 percent.

While 25 of the euro zone's biggest banks didn't have enough capital to withstand a series of potential financial shocks at the end of last year, in stress tests run by the European Central Bank (ECB), most have since raised enough capital or sold off enough assets to repair their balance sheets, the ECB said on Sunday.

Banks in focus in Monday's trading included most of the Italian lenders, after nine failed stress tests.

Some of the larger banks which narrowly passed the tests include Italy's Mediobanca and UniCredit. Banco Popolare rose 1.92 percent as investors breathed a sigh of relief. The broader banking sector dropped 1.73 percent.

Spain's banks were broadly higher, and Austrian banks Erste Bank and Raiffeisen also saw strong gains, with the former up over 3.4 percent and the latter gaining almost 6 percent.

The U.K.'s Lloyds Banking Group was down 1.9 percent after it narrowly passed the test.

"We think the outcome of the ECB's Comprehensive Assessment is positive for the European banking sector. We believe bank spreads in Europe will continue to tighten and lending conditions and credit constraints should ease, especially in the periphery," analysts at Barclays said.

After opening stronger, U.S. stocks were down in midday trading with the Dow Jones average off 0.14 percent.