LONDON European stocks eked out a gain and Italy paid a record low yield at two bond auctions on Friday, as investors shrugged off any threat of contagion from a Portuguese bank's problems.
European shares were still on track to post their worst weekly fall in three months, however, as investors reassessed stretched valuations for global equities and a slower-than-expected economic recovery in the euro zone.
The pan-European FTSEurofirst 300 .FTEU3 index was up a third of one percent, but was still on track for a weekly loss of almost 3 percent.
Portugal's PSI 20 index was up 1.4 percent after the country's largest bank, Banco Espirito Santo (BES.LS), reassured investors overnight about financial troubles at its biggest shareholder.
Espirito Santo shares were down 2 percent, however, extending Thursday's 19 percent plunge, which had sent ripples across Europe, U.S. and Asia trading. The losses bucked a months-long trend of low volatility and bullish sentiment towards stock markets driven by steady monetary support from major central banks.
Shares in Portugal's largest listed lender were down more than 30 percent so far this week, easily the worst week on record.
"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 saw little movement. German bund futures FGBLc1 traded flat and peripheral euro zone bonds, a recent winner for return-hungry investors, saw yields track lower. They had risen sharply on Thursday, when Portuguese 10-year yields PT10YT=TWEB fell 10 basis points to 3.91 percent.
The calmer market enabled Italy to sell 7.5 billion euros of bonds, the top of its targeted range, in an auction that sharply contrasted with Greece's three-year bond sale on Thursday, where demand was hurt by fallout from Portugal.
The yield on both the three-year and 15-year paper was the lowest paid at auction since the euro was launched in 1999.
"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.
Currency markets were largely steady, with the dollar .DXY flat against a basket of six major currencies.
Sterling pared gains against the dollar and slipped against the euro after data showed British construction output fell in May, suggesting some sectors in the economy were signs of cooling.
U.K. shares were buoyed by merger hopes, as Imperial Tobacco (IMT.L) rose 3.4 percent after saying it was in talks with Reynolds (RAI.N) and Lorillard LO.N to acquire certain assets and brands from the two companies.
Moves in Asia were 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 .MSCIEF was down 0.5 percent. Emerging-market stocks were 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.
The catalyst for a more significant emerging markets correction would be a hawkish turn by the U.S. Federal Reserve, Citi strategist Ishitaa Sharma said, predicting the current low-interest rate environment would keep investors chasing carry - the higher yields available in emerging markets.
MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS dipped 0.2 percent. Japan's Nikkei .N225 pared losses to end off 0.3 percent.
Investors were 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 LCOc1 was off 51 cents at $108.16 a barrel. U.S. crude CLc1 lost 44 cents to $102.49.
(Additional reporting by Patrick Graham, Emelia Sithole-Matarise, Chris Vellacott and Tricia Wright; editing by Larry King)