European shares hit two-week lows, yen rises as Japan backs stimulus

European stocks fell to two-week lows on Tuesday, dragged down by banks, while the yen rose against the dollar and government bonds sold off after Japan's cabinet approved a fiscal stimulus package to revive the flagging economy.

Oil fell again, with US crude dipping below $40 a barrel as a supply glut weighed on prices.

The pan-European STOXX 600 index fell 1.4 per cent, hurt by a 3 per cent fall to three-week lows in banks. They extended Monday's losses after Europe-wide stress tests on 51 European lenders cast doubts on the health of the sector.

Credit Suisse fell 5.6 per cent and Deutsche Bank 3.2 per cent after index provider STOXX said the two banks would be dropped from Europe's STOXX Europe 50 index from next Monday.

Germany's Commerzbank shares reached a record low, down more than 8 per cent after it warned its earnings would fall this year because of customer caution and negative official interest rates.

Italy's Monte dei Paschi fell 6 per cent and UniCredit 4 per cent.

MSCI's broadest index of Asia-Pacific shares outside Japan was down 0.4 per cent, after the S&P 500 ended Monday 0.1 per cent lower, despite reaching an intraday record high.

Australian shares fell 0.8 per cent after the Reserve Bank of Australia cut its main interest rate by 25 basis points to a record low of 1.50 per cent, as expected. Hong Kong trading was suspended as Typhoon Nida shut down most of the financial hub.

Sliding oil prices and the stronger yen pushed Tokyo's Nikkei index down 1.5 per cent.

The yen rose to its strongest in three weeks at 101.60 per dollar after Japanese Prime Minister Shinzo Abe's cabinet approved on Tuesday 13.5 trillion yen ($132.04 billion) in financial steps as part of efforts to revive Japan's economy.

Last week, the Bank of Japan announced further easing steps, which disappointed investors who had hoped for more.

"There's quite a lot of scepticism in the market as to whether this fiscal package can change anything. Japan has already tried this a number of times and everyone knows it's not really as big as the headline figure suggests," said Alvin Tan, a strategist at Societe Generale.

"What was exciting over the past month was the potential for monetary policy to act in coordination with the financial measures and we were definitely disappointed on that front last week. Coordination still seems a good way off."

Japanese government bonds suffered their worst sell-off in more than three years on fears the BOJ would slow its bond-buying.

That had a knock-on effect in the euro zone, where government bond yields rose across the board. German 10-year yields, the benchmark for borrowing costs in the bloc, rose 2.2 basis points to minus 0.13 per cent.

The dollar held near three-year lows after soft US economic data on Monday undermined the case for an early rate increase by the Federal Reserve.

The dollar index against a basket of six major currencies fell 0.3 per cent. It recorded its biggest decline in three months last week and has since struggled to recover.

The Australian dollar fell as low as $0.75 after the RBA decision, then recovered to trade up 0.3 per cent at $0.7560. Australian shares were 0.6 per cent lower.

US crude oil futures slipped back below $40 a barrel. They fell to their lowest level since April on Monday on worries that a global oil glut is undercutting prices.