European markets settle after Portugal-led rout

On track to post sharp weekly loss as investors reassess valuations for global equities

European stocks opened firmer and lower-rated government bond prices edged up on Friday, as markets settled after a broad pullback overnight on concerns about Portugal's banking sector that highlighted contagion risk in the euro zone.

European shares were still on track to post a sharp weekly loss as investors reassess stretched valuations for global equities amid a slower-than-expected pace of economic recovery in the euro zone.

The pan-European FTSEurofirst 300 index opened 0.4% higher, buoyed by gains across the region. Portugal's PSI 20 index was up 1.5% after its biggest lender Banco Espirito Santo reassured investors overnight over financial troubles at its biggest shareholder.

Espirito Santo had plunged 19% on Thursday before trading was halted, sending ripples across Europe, US and Asia trading and bucking a months-long trend of low volatility and positive sentiment for stock markets driven by steady monetary support from major central banks.

"The market is very confused at the moment with people not sure about the strength of the economic recovery and worries about structural issues that have not been resolved," Lex Van Dam, a hedge fund manager at Hampstead Capital, said.

Fixed income markets were cautious, with German bund futures trading flat. Peripheral euro zone bonds, a recent winner for return-hungry investors, saw yields track lower after a sharp rise on Thursday, with Portuguese 10-year yields dropping 10 basis points to 3.91%.

"After the huge rally behind us in non-core bonds as well as equities we've had a multitude of bad news...The market clearly needed a trigger for profit-taking and that's what happened," said Jan von Gerich, chief fixed income analyst at Nordea.

"It's a reminder that volatility is not dead and that not all the banking sector issues have been resolved."

Forex markets were largely steady, with the dollar also flat against a basket of six major currencies.

EMERGING CAUTION

In the UK, shares were buoyed by merger hopes, with Imperial Tobacco up 2.9% after saying it was in talks with Reynolds and Lorillard to acquire certain assets and brands that could be sold by the two companies.

Moves in Asia had been generally modest with share markets mixed. Hong Kong, South Korea, Taiwan and the Philippines lost ground but China, Singapore and Australia eked out gains.

The MSCI Emerging Market index was down 0.4%, with emerging stocks set for the biggest weekly loss since the end of May and Indian shares headed for their biggest weekly loss since the end of January.

MSCI's broadest index of Asia-Pacific shares outside Japan dipped 0.3%, while Japan's Nikkei pared losses to end off 0.3%.

Investors had been encouraged by signs that funds were taking money out of peripheral euro zone debt and seeking higher returns in the emerging world. MSCI's index of emerging market stocks actually rose on Thursday having hit a 17-month peak earlier in the week.

As tensions in the Middle East simmered, Brent crude oil was off 63 cents at $108.04 a barrel, while US crude lost 50 cents to $102.43.