European stocks dropped sharply on Friday and the euro lost ground as euphoria over the strategy to resolve euro zone debt crisis dissipated and worries over the contagion spreading to Italy resurfaced.

Stock exchanges across Europe shed Thursday’s gains in the wake of a deal by EU leaders to contain the debt crisis that included a plan to expand the euro zone bailout fund to €1 trillion and an agreement with banks to write down 50 per cent of Greece’s debts.

In a repeat of the events preceding the first bailout of Greece in May last year, Italy’s borrowing costs for 10-year bonds jumped to 6.06 per cent, the highest level since the creation of the single currency over 10 years ago, as speculators began targeting the country as the next candidate for a bailout.

Besides, the Italian Treasury failed to raise €8.5 billion it had hoped for and had to end Friday’s auction with €7.9 billion, indicating further drop in investor confidence in the country’s economy.

Italy’s debt of 120 per cent of the GDP is one of the highest in the euro zone, it has a budget deficit of 60 per cent compared to the 3 per cent limit set by the euro zone stability pact and its economy has been stagnating for years.

Investors are becoming increasingly concerned that higher borrowing costs to repay its debts will push the country to the brink of a default.

Besides, a German court’s decision, which complicates the implementation of the euro zone bailout fund —the European Financial Stability Facility (EFSF) — also weighed heavily on the financial markets.

Germany’s benchmark index DAX, which went up by around 5 per cent on Thursday, dropped 0.1 per cent and closed at 6,346 points.

In London, the FTSE 100 index fell 0.20 per cent to 6,702 points and in Paris, the CAC closed 0.59 per cent lower at 3,348 points.

Banking shares, which made a strong rally on Thursday, shed most of their gains and were among the worst hit in Friday’s trading.

Germany’s Commerzbank fell 4.3 per cent and Allianz lost 1.01 per cent, while Deutsche Bank closed 1.2 per cent higher. French banks gained in Friday’s session in spite of their heavy exposure to Greek debts.

The euro closed at $1.4149, 0.24 per cent lower from Thursday’s close.

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